80627 Mexico reform agenda for inclusive and sustainable growth W O R L D B A N K M E X I CO Mexico reform agenda for inclusive and sustainable growth Copyright © 2013 by The International Bank for Reconstruction and Development / The World Bank. 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. Internet: www.worldbank.org.mx All Rights Reserved Printing and Manufactured in Mexico / 2013 First Printing: June, 2013 This work is a product of the staff of The World Bank. The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. 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Content: Fostering sound financial sector development. – Toward a more competitive business environment. – Fostering innovation for productivity and competitiveness. – Labor markets for inclusive growth. – Promoting an integral social protection system. – Reducing the footprint of growth. – Using natural resources in an optimal way. – Managing medium-term fiscal challenges. – Strengthening public revenue and expenditure management to enhance service delivery. -- Strengthening subnational public finance. 338.97221/A45 Contents Summary Matrix of 20 Top Policy Reform Options························································································································ 4 1. Fostering Sound Financial Sector Development····················································································································· 7 2. Toward a More Competitive Business Environment·········································································································· 19 3. Fostering Innovation for Productivity and Competitiveness······················································································ 33 4. Labor Markets for Inclusive Growth················································································································································ 45 5. Promoting an Integral Social Protection System·················································································································· 63 6. Reducing the Footprint of Growth··················································································································································· 79 7. Using Natural Resources in an Optimal Way···························································································································· 93 8. Managing Medium-Term Fiscal Challenges ·························································································································· 107 9. Strengthening Public Revenue and Expenditure Management to Enhance Service Delivery····· 119 10. Strengthening Subnational Public Finance··························································································································· 131 Summary Matrix of 20 Top Policy Reform Options Unleashing Productivity • Improve competition in the telecommunications sector by completing and enforcing an integral interconnection policy • Integrate competition principles in national and subnational regulations by establishing a high- level commission to eliminate anticompetitive market regulations at the subnational level • Simplify the judicial process for claim enforcement with special attention to repossession of collateral to facilitate secure credit • Foster innovation by increasing the levels and effectiveness of public research and development programs and promoting greater collaboration between the private sector and scientific institutions. • Improve the role of the labor market in raising productivity, on the demand side (i) by modifying the Federal Labor Law to increase flexibility of hiring through short-term trial and training contracts; and on the supply side (ii) by implementing a skills development plan such that schools, training institutes, and the private sector can equip workers with the skills required to raise productivity; and by strengthening labor intermediation services and skills certification processes Reducing Poverty and Inequality • Strengthen the performance of social protection flagship programs by separating functions (service provision, regulation, financing) in Seguro Popular and by expanding Oportunidades to support young children and to the youth transitioning into the labor market • Improve the coverage of the social protection system to protect the elderly and those affected by shocks such as natural disasters or economic crises, and to reduce the middle class’s vulnerability to poverty, by adapting existing social programs or creating new programs • Develop a unified registry of beneficiaries of social programs and interoperable information systems to improve system efficiency through better targeting, portability, and coordination • Strengthen the redistributive role of fiscal policy by strengthening ex ante and ex post impact evaluation of the distributional impact of any proposed fiscal reforms (tax revenue measures and public expenditure programs) and introduce targeted compensatory measures as required mexico reform agenda for inclusive and sustainable growth 4 Promoting Green and Inclusive Growth • Improve urban and disaster risk management by strengthening municipal building codes for disaster prevention; improving the quality of risk identification tools (risk atlas); and promoting integration with land use planning • Promote energy efficiency by allowing private sector participating in the financing of key investments in renewable energy • Promote the ‘brown agenda’ by reviewing the municipal legal framework for an effective implementation of municipal programs for integrated prevention and management of waste • Strengthen water management by reviewing all related federal programs to improve their targeting, alignment, and predictability, including the assessment of electricity subsidies • Improve forest management by balancing reforestation and community forestry, restoration, and payment for environmental services funds; and by promoting a landscape approach, in coordination of agriculture, livestock and forestry sectors Promoting Sound Public Finance and Efficient Government • Reduce dependency on oil dependency by raising tax revenue through a tax reform that broadens the tax base, simplifies tax filing, reduces tax expenditures, and eliminates special regimes and preferential rates • Improve efficiency and equity of energy taxes and subsidies through an energy pricing reform: (i) adopting a fixed excise tax on domestic fuel sales, allowing prices to fluctuate with international price movements; and (ii) reducing general subsidies on electricity for use in housing and agriculture ( including instead compensatory programs targeted to low income households) • Reduce budget volatility through the implementation of stabilization measures, including: the institutionalization of oil price hedges; the removal of caps on stabilization funds; and the adoption of a structural fiscal balance rule. • Strengthen the capacity for tax administration and tax collection at the federal and subnational levels by moving towards electronic tax payments; improving tax audit capacity; improve property valuation and cadastre management; and moving towards a single tax registry • Improve the quality and transparency of public expenditure by implementing and consolidating at the federal and sub-national levels three related reform agendas: performance-based budgeting agenda; the integrated public financial management system (SIDAFF) agenda, including the implementation of the single treasury account; and the accounting harmonization agenda. mexico reform agenda for inclusive and sustainable growth 5 mexico reform agenda for inclusive and sustainable growth 7 Fostering Sound Financial Sector Development Executive summary Message 1. Mexico needs to broaden and deepen its financial system while preserving the financial stability gains of the last decade. Message 2. Sound financial development requires continuing (i) improving financial infrastructure (including retail payment systems, credit bureaus, and collateral registries), (ii) fostering capital market development, and (iii) strengthening consumer pro- tection and financial literacy. Message 3. The government should periodically review its strategy of lowering regulatory barriers to foster competition in the financial sector and its pro- cedures for resolving failed institutions. The state’s role in financial services should be comprehensively evaluated. mexico reform agenda for inclusive and sustainable growth 8 Objective This note outlines a short- to medium-term reform agenda to foster sound financial sector development. Mexico needs to broaden and deepen its financial system without compromising the financial stability gains of the last decade. Much more private investment is needed to transform the economy to boost productivity, and despite improvements in recent years, many households and firms still lack adequate access to financial services. Using the financial payments system to promote financial inclusion is a sound way to broaden access. However, experience in several countries has shown that accelerated (or forced) expansion of credit can harm rather than benefit customers. If financial institutions do not follow sound practices, they can fail, harming borrowers and depositors alike and creating social unrest. Institutional failures may also lead to costly bailouts, with substantial fiscal cost. An oversight system (both micro- and macro-prudential) that encourages prudent-risk taking and fa- cilitates prompt resolution of failed institutions ensures that strategies for financial deepening do not compromise financial stability. Key challenges Mexico’s financial sector is small for the country’s stage of development, impeding the channeling of finan- cial savings into long-term productive investments. Commercial bank credit to the private sector is well below the level in countries with similar characteristics and below the regional average (figure 1). Similarly, the size and depth of capital markets are well behind levels in peer countries. While the market for government debt is deep and liquid, there are few issuers in the nongovernmental bond and corporate equity markets. The system has done a fair job of mobilizing savings in recent years but continues to lag in risk taking and maturity trans- formation, limiting its contribution to growth. At less than 35 percent of GDP, total financing to the private sector (including domestic and external sources) has yet to recover to its mid-1990s levels (figure 2). Commercial bank lending is increasingly focused on consumer credit, which has higher intermediation margins.2 Institutional investors, including pension funds and mutual funds, hold most of their assets in fixed-income securities, mostly government bonds. mexico reform agenda for inclusive and sustainable growth 9 FIGURE 1. Financial development in Mexico Private Credit / GDP (%) Stock Market Capitalization / GDP (%) 50.0 100.0 45.0 90.0 40.0 80.0 35.0 70.0 30.0 60.0 25.0 50.0 20.0 40.0 15.0 30.0 10.0 20.0 5.0 10.0 0 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Value Observed Value Observed Regional Median Expected Median Regional Median Expected Median Stock Market Turnover Ratio (%) Insurance Company Assets / GDP (%) 70.0 100.0 90.0 60.0 80.0 50.0 70.0 60.0 40.0 50.0 30.0 40.0 20.0 30.0 20.0 10.0 10.0 0.0 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Fostering sound financial sector development Value Observed Value Observed Regional Median Expected Median Regional Median Expected Median Pension Fund Assets /GDP (%) Mutual Fund Assets / GDP (%) 30.0 10.0 9.0 25.0 8.0 7.0 20.0 6.0 15.0 5.0 4.0 10.0 3.0 5.0 2.0 1.0 0.0 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Value Observed Value Observed Regional Median Expected Median Regional Median Expected Median Source: FinStats 2011/World Bank. mexico reform agenda for inclusive and sustainable growth 10 FIGURE 2. Total financing to the private sector has yet to recover to its mid-1990s levels Total nancing to non nancial private sector Commercial bank nancing to the private sector (as a share of GDP) (as a share of GDP) 60.0% 35.0% 50.0% 30.0% 25.0% 40.0% 23.9% 20.0% 7.7% 30.0% 15.0% 20.0% 7.7% 10.0% 25.1% 8.5% 10.0% 5.0% 5.6% 0.0% 0.0% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Internal External Househods Companies Source: GEA, based on data from Banco de Mexico and Inegi Source: GEA, based on data from Banco de Mexico and Inegi While a variety of financial institutions operate According to 2010 World Bank Enterprise Surveys, in Mexico, the financial system is dominated by only 32 percent of manufacturing firms have a bank conglomerates that control banks and distribution loan or credit line, well below world (56 percent) and channels for securities. Barriers to entry have been regional averages (48 percent). Widespread infor- reduced to deepen credit markets. Unregulated, non- mality and high collateral requirements (more than deposit-taking financial institutions (Sofoles and double the value of the loan) limit access to credit. Sofomes) were permitted to operate in the market, Large banks typically require firms seeking loans to and paid-in capital and regulatory requirements were hold compensatory balances, which are particularly lowered for niche banks, which engage in a more limi- high for small and medium-size enterprises (SMEs). ted range of activities than regular banks. In addition, Only 20–25 percent of SMEs have access to bank unregulated credit cooperatives operate (mostly) in credit, mainly through public credit guarantee sche- rural areas, reaching more than 2 million customers. mes. Commercial bank lending tends to be short Fostering sound financial sector development Public financial institutions provide about a third term and costly, with deficiencies in the procedures of total credit to the private sector, largely through for collecting on collateral reflected in high bank two provident housing funds (INFONAVIT and charges. FOVISTE). Despite the important size of public institutions, commercial banks still account for more than half of total credit to the private sector. The seven largest financial groups hold or manage about Policy options three-quarters of total financial assets, undermining efforts to increase competition among financial pro- viders and diversify sources of funding. Conflict of Expanding the infrastructure for interest problems pervade financial transactions. financial payments services to bring Despite extensive efforts to expand access, the households into the financial system financial system does not meet the financial ser- vices needs of many households and firms. Half Household use of financial payment services the population still does not use financial services can be expanded by widening the correspondent despite recent reforms to simplify accounts and re- bank network, encouraging the use of non-cash gulate correspondent banking services and mobile payment services by revising fee regulations, and phone banking services. Findex data indicates that increasing competition in the newly launched only 27 percent of the population 15 years of age and mobile payments platforms. Correspondent bank older have an account in a formal financial institu- networks need to be expanded beyond the more esta- tion (compared to a regional average of 39 percent). blished retail franchises (such as OXXO, Telecomm, mexico reform agenda for inclusive and sustainable growth 11 7-Eleven) to reach into individual mom-and-pop margin). This would allow using the real state asset shops. Otherwise, cash in/cash out prices may re- to secure more than one loan. main high because of limited competition, and co- Strengthening enforcement proceedings for rrespondent banks will not spread into underserved secured and unsecured credits is essential for redu- poor and rural areas. One way to expand access is to cing economic losses and credit costs. Debtors have allow deposit-taking credit cooperatives to sign up a variety of means to delay insolvency enforcement, correspondent banks on the same terms as banks. and local courts lack adequate enforcement capacity.4 Fee regulations should support the development of Secured creditors’ recovery prospects are hampered new, cheaper channels and product offerings.3 For by the unlimited priority of worker claims on liqui- example, because banks do not charge customers for dation procedures, debtor recourse to judicial pro- making cash deposits and withdrawals at the bank’s cedures, and weak police support in executing court own automated teller machines (ATMs) or bran- resolutions. While trusts can be used to pledge assets ches, customers often believe that cash is costless. In and avoid the need for judicial procedures, the cost is fact, debit cards and electronic payments are more prohibitive for small firms. Using more out-of-court cost-effective for many transactions. Also, banks enforcement mechanisms and simplifying inefficient may be discouraged from expanding their network judicial procedures would benefit the entire credit of ATMs or branches to remote areas because of protection system. higher restocking, safeguarding, and cash collection Small and medium-size firms need easier access costs, forcing customers to use higher priced corres- to insolvency procedures. Though the insolvency pondent banks. Finally, recent regulatory changes law was reformed in 2000 and 2007, it is rarely have paved the way for mobile phone providers to used. Thousands of businesses are liquidated every operate mobile payment/banking schemes through year, with serious loss of economic value, but only banks. Care is required to ensure that the leading about 400 insolvency cases were brought in the mobile operator is not able to transfer its dominan- law’s first 10 years—and more than a third of those ce in the telephony market into mobile payments were dismissed. The chief reasons are the lack of (and back). civil liability of company directors and officers for insolvency, weak incentives for debtor and creditors to use the system, and high financial and transaction Strengthening creditor rights costs. While the law contains a complete framework and insolvency procedures for liquidating a business, important technical flaws Fostering sound financial sector development remain. For example: criteria for initiating a claim Improving the collateral registration system, are unnecessarily complex, resolution of the insol- especially for real estate, and introducing certi- vency proceedings does not discharge the debtor of ficates of collateral could improve firms’ access its obligations, and creditors do not participate in to credit. Setting up the Unified Secured Transac- the process through a creditors’ meeting or creditor tions Registry for security interests over movable committees. assets is an important step toward modernizing Reorganizing a businesses is extremely difficult. the collateral registration system. However, the Especially disappointing has been the “conciliationâ€? cost to register real estate assets is high (largely phase of insolvency proceedings, meant to facilitate because of high notary fees), and inefficiencies an agreement that could preserve the business. Fewer persist, especially in some states. Registry systems than 100 insolvency plans have been approved under are not computerized or connected, and there are the new insolvency law, and no data are available discrepancies in cadastral information, making about the success of those plans. The legal framework the system slow and unreliable. Application of the sets out numerous obstacles to successful reorganiza- Federal Model for the Modernization of Registries tion that leave large groups of creditors unaffected by could improve the situation. Also, real estate assets the insolvency plan, including inflexible procedures, could be used more efficiently by introducing a lack of post-petition finance, lack of appropriate Chilean-style reform. Following this reform, the treatment for executor contracts, the ability for some registry would issue certificates of collateral that creditors (such as the workers) to bring claims outsi- fragment the value of the pledged asset to cover de the insolvency process, and the opaqueness of the only the loan amount (plus an overcollateralization rules for approving insolvency plans. mexico reform agenda for inclusive and sustainable growth 12 BOX 1. The Mexican Credit Reporting System Two consumer credit reporting bureaus operate in Mexico, Buró de Crédito and Círculo de Crédito.1 Buró de Crédito collects credit information from most banks and some nonbank financial institutions, retailers, and other creditors on more than 68 million individuals and 3 million firms. For firms, the database includes information on credit only, not on balance sheets, accounts receivable, or other information related to trade credit. Firms provide the information voluntarily. Círculo de Crédito focuses on consumer credit and microcredit and provides information from two retail banks and cable and telephone companies on 40 million individuals. In addition, specialized law firms provide information on court judgments. The Law on the Regulation of Credit Information Societies (SIC) establishes the legal framework for credit reporting. The law includes mechanisms for protecting privacy rights, such as requiring consent before accessing an individual’s or firm’s credit reports, and low-cost procedures for consumers challenging erroneous information. It also mandates that all regulated financial institutions report their loan activities to and access information from the credit bureaus as part of their credit application process. Credit bureaus are required to exchange negative information in their databases monthly and to exchange positive information on individual borrowers whenever they issue a report on a borrower (this provision has been challenged in court). Banxico issues rules governing how long credit bureaus may retain negative information in their databases. Under SIC, private credit reporting bureaus must be authorized to operate by the Secretariat of Finance and Public Credit, and they are supervised by the National Banking and Securities Commission, subject to regulations issued by Banxico. The commission conducts annual and ongoing examinations to verify adherence to the law. Examinations focus on con- sumer privacy and legal compliance. The commission is limited in its ability to address problems proactively, as it has no mandate to deal directly with the public on potential violations or with nonbank authorizers of credit. Additional consumer protection laws establish mechanisms for consumers to dispute credit agency data.2 The Natio- nal Commission for the Protection of Financial Services Users deals with all disputes involving credit bureaus, all regulated financial institutions, and non-deposit-taking financial institutions, such as Sofomes. The National Consumer Protection Agency handles disputes involving commercial entities, including credit cards issued by nonfinancial institutions (such as department stores) and telecommunication companies. 1 Buró de Crédito is made up of two firms, TransUnion de México S.A., S.I.C. and Dun & Bradstreet S.A., S.I.C. The first firm is a joint venture of TransUnion and the Mexican commercial banks. 2 The Law on Consumer Protection for Financial Services (2005), Law on Transparency, and the Federal Law on Consumer Protection. Fostering sound financial sector development Enhancing credit information systems information between credit bureaus needs to be to facilitate sound credit expansion settled. In addition, credit information sources could be expanded to include utilities, government credit Credit histories provided by the Mexican credit in- programs, unregulated financial institutions, court formation system are often inaccurate, incomplete, judgments, fraud alerts, and property registries. and fragmented, despite recent reforms. Efficient Mexico’s National Banking and Securities Commis- credit reporting systems improve access to credit by sion could also consider sharing information from its reducing asymmetric information problems between credit registry. borrowers and lenders. Deficiencies in Mexico’s The legal and oversight framework for credit re- credit information system prevent it from serving porting needs strengthening. The legal and regula- this function (box 1). The fact that there are credit tory framework needs to be modernized to encourage histories for some 70 million people (63 percent of innovation and competition and better serve industry the population) is obvious evidence of fraud and needs. By strengthening data quality and facilitating errors, considering the country’s low access to credit. data sharing, asymmetries of information between A national identification system with unique indivi- borrowers and financial institutions will be narrowed dual identifiers is needed to reduce fraud and error. and new lending institutions will gain access to Several steps could be taken to expand information records—all of which should encourage competition coverage and lessen fragmentation. An unresolved and provision of new services by bureaus such as legal impediment to plans for exchanging borrower scoring models and facilitate access to credit. System mexico reform agenda for inclusive and sustainable growth 13 upgrading should go beyond legislative changes and Users (CONDUSEF), so that it can effectively dis- address mandate overlaps (in consumer protection charge its mandate. issues, for example) and regulatory gaps and ensure The plans for capital market development that supervision covers more than legal compliance. should be spelled out in a road map that can serve as a reference point for future administrations and for an effective promotion campaign. The cam- Developing capital markets to paign should include a joint public-private effort to deepen the financial system promote all segments of the Mexican capital market domestically and abroad. Aggressive financial edu- To foster capital market development, priority cation efforts with domestic investors and potential should be given to reforms that strengthen access issuers should also be promoted, while the Mexican and competition, while preparing the grounds for Stock Exchange could provide special services (such more extensive reform. Near-term reforms should as independent research for smaller companies) to focus on facilitating access, opening the market to attract new issuers. To improve financing before an independent players, and deepening integration with initial public offering, consideration should be given foreign markets. Access could be improved by strea- to incentives (such as tax credits or deductions) that mlining the regulatory framework for investment could mitigate the large risks of investing in initial funds and encouraging the growth of independent public offerings and debt placements by the second- distribution channels. Narrow licenses for interme- tier group of companies. diaries (such as specialization in brokerage activities The pension system should be reformed so that only) could be reconsidered to make it more afforda- capital markets are more effective for insuring ble for independent players to enter the market. The against longevity risks, especially by raising re- financial regulator could consider creating a hybrid placement rates and reforming the regulatory fra- regime within the public offer framework for specia- mework. Contribution rates may need to be raised lized instruments that waives the prospectus requi- to achieve reasonable replacement rates.7 In addition, rement for issues targeted to professional investors.5 a regulatory shift is needed from a value-at-risk The regulatory framework for pension funds needs approach that limits short-term return volatility to to incentivize risk-taking (see discussion below). an approach focused on long-term investment per- Another way to raise the quality of services would formance. Other concerns include excessive and so- be to deepen integration with other markets, such as cially wasteful competition between funds driven by Fostering sound financial sector development Brazil, the Mercados Integrados Latinoamericanos participants’ focus on factors other than replacement (comprising Chile, Colombia, and Peru), and the rates; the use of derivatives for leverage rather than United States. hedging; limited diversification and rapid accumu- Over the medium term the strategy should in- lation of resources, which could lead to mispricing clude bringing large issuers into securities markets of domestic assets; and a need for more balanced and improving capital markets oversight. Bringing corporate governance of pension funds. The overre- the energy and banking sectors into the public equity gulated annuities market, especially restrictions on market could greatly increase the supply of securities pricing and technical parameters, discourages effec- and market capitalization and boost participation by tive competition. Other features of the regulatory both foreign investors and domestic retail investors. framework that could be improved include selection State-owned companies will need to upgrade their of the reference interest rate, investment regulations, governance and line up political support. The regula- and contract policies. tor will need to strengthen supervision and enforce- ment related to potential conflicts of interest by large financial conglomerates; strengthen regulation and Improving financial literacy and supervision of related-party transactions to boost strengthening consumer protection investor comfort; harmonize Mexican standards with those of Brazil, Chile, and other peers;6 develop The powers and financing of CONDUSEF a legal framework for derivatives; and strengthen should be increased to deal with the complexities the power and enforcement capacity of the National of financial services. CONDUSEF is responsible Commission for the Protection of Financial Services for promoting financial education, establishing mexico reform agenda for inclusive and sustainable growth 14 consumer protection rules, and responding to con- Law. Options should include supporting mergers sumer complaints about financial services firms, of weaker entities with stronger ones and resolving while the National Consumer Protection Agency failing cooperatives through purchase and assump- (PROFECO) is responsible for protecting consu- tion techniques. Resolution procedures need to be mers from deficiencies in general goods and services. improved for bank and corporations (non-regulated CONDUSEF is particularly important because of financial intermediaries). the prevalence of conglomerates, which increases The state has a large presence in the Mexican fi- the scope for conflict of interest, and the low level nancial system, and it is important to ensure that its of consumer financial education. However, CON- interventions foster rather than impede financial DUSEF lacks the power to demand compensation development. State development banks and provi- or arbitrate disputes, and its financing is inadequate dent housing funds provide about a third of private to meet its objectives. Some functions handled by sector credit. The state also provides partial credit PROFECO should be transferred to CONDUSEF. guarantees and subsidizes other financial products, In coordination with other entities, including Na- such as agricultural insurance. Over the last decade tional Banking and Securities Commission and the reforms have greatly reduced the size of development Ministry of Education, and based on the results of an banks, improved their governance and professio- ongoing financial capabilities survey, CONDUSEF nalism, and focused their activities on catalyzing could mount a comprehensive program of financial financial sector participation. It is important to literacy, as Brazil and Peru have done. preserve and continue advancing on such reforms to ensure effectiveness of development bank operations. The provident housing funds, however, still focus on Revising the national strategy to develop the direct lending. As part of important countercyclical financial system to support sound access measures during the recent financial crisis, credit guarantee programs and development bank balance Lowering prudential requirements to ease entry sheets expanded substantially (increasingly through may help develop the system, but constant moni- tier I operations), though their portfolio remained toring is required to ensure that failing institutions below 2006 levels. A strategy for public sector enga- can exit the market in an orderly fashion. Broade- gement in the financial sphere should clearly define ning the range of financial operators and services when direct lending is preferred to tier II operations by lowering regulatory barriers to entry implies and when to switch between the two. The strategy Fostering sound financial sector development some risk to sound financial development. Thus, this should also include plans for partner arrangements strategy needs to be continuously monitored and between provident housing funds and private credit adjusted in line with the system wide risks posed by a institutions, and mechanisms for reducing develop- collective failure of the growing number of financial ment bank’s balance sheet once a crisis has passed institutions. Flexibility needs to be built into the in order to maintain profitability and avoid excessive system for creating and liquidating such institutions risk taking. Finally, to ensure that resources are being to avoid disrupting the system or causing social used efficiently, the addition of multiple public inter- upheaval. A priority is devising a plan for resolving ventions in the financial sphere should be evaluated the credit cooperatives that did not met the end- to assess the impact on productivity and growth and 2010 deadline imposed by the Credit Cooperative to rationalize program portfolios. mexico reform agenda for inclusive and sustainable growth 15 Matrix of short- and medium-term policy reform options* Reform areas Short-term policy options Medium-term policy options · Simplify authorization procedures · Introduce a national identification system to for correspondent banks (AR) improve the quality of credit bureau data (AR). · Allow deposit-taking credit cooperatives · Review the legal and oversight to sign up correspondent banks on framework for credit bureaus (LR). Improving financial the same terms as banks (LR). · Reform real estate registries along the lines of infrastructure · Revise fee regulations to encourage the the registry for movable guarantees (LR). use of non-cash payment methods (AR). · Reform the legal framework for insolvency · Allow registries to issue certificates of collateral and business reorganization to increase its for more efficient use of eligible assets (AR). use (particularly by smaller firms). (LR) · Simplify procedures for executing collateral (LR). · Create narrow licenses for intermediaries (LR). · Require the listing of banks and partial · Create a hybrid regime within the listing of public companies (LR). public offer framework (LR). Developing · Review the regulatory framework · Formulate a strategy for regional capital markets for annuities (HI/AR). capital market integration (AR). · Streamline the regulatory framework · Reform the regulatory framework for pension for investment funds (HI/ AR). funds and increase replacement rates (LR). Strengthening · Strengthen CONDUSEF’s powers and resources (LR). consumer protection · Formulate a strategy to enhance and financial literacy financial literacy (AR). · Develop a strategy for the resolution · Review public sector credit programs and Revising overall of cooperatives (AR). formulate a comprehensive strategy for strategy for increasing · Review the role of provident housing development bank operations (AR). competition in the funds and increase their cooperation · Approve draft modifications to bank financial sector with the private sector (AR). resolution procedures (LR). *LR/AR= Legal or Administrative Reform. Preliminary Classification. Fostering sound financial sector development mexico reform agenda for inclusive and sustainable growth 16 Notes 1 This note was prepared by Eva Gutierrez (Lead Financial Sector Specialist, LCSPF), supported by the substantial package of advisory services that the World Bank has provided in recent years to the Mexican financial authorities. These services include the 2011 Financial Sector Assessment Update (FSAP), the 2011 Report on Compliance with International Stan- dards for Insolvency and Creditor Rights, ongoing work on designing a strategy for the resolution of weak unregulated cooperatives in Oxaca, and the 2010 advisory and convening services on public development institutions. 2 Housing and household credit account for 36 percent of total credit and 66 percent of the interest generated from commercial bank loans. Business loan portfolios account for 47 percent of total portfolios but generate only 25 percent of interest income. 3 In July 2010 Banxico published reforms dealing with financial charges and fees (Circular 22/2010). The new rules prohibit credit-granting institutions from charging fees for opening and closing on-demand savings accounts; for cancelling cre- dit cards, debit cards, or prepaid credit cards; for e-viewing balances; for withdrawing cash at automated teller machines belonging to the customer’s own bank; and for accessing banking services at a teller window at a branch bank. 4 Mexican banks that handle large volumes of collections report an average recovery time of two years for secured creditors; unsecured creditors are rarely taken to court. Mortgage foreclosures can be frustratingly slow, averaging three to five years. 5 Pension funds have been able to invest in private equity only through special instruments called Certificados de Capital de Desarrollo (CKDs). However, CKDs are a second-best solution that limits the scope of investor due diligence to public information. As a result, not all relevant players have agreed to use CKDs, and pension funds are extremely selective about which fund managers they choose to operate with. 6 For example, by strengthening supervision and enforcement. 7 Under reasonable assumptions, the 6.5 percent contribution rate will be unlikely to allow that—particularly for middle- class contributors. Fostering sound financial sector development mexico reform agenda for inclusive and sustainable growth 17 mexico reform agenda for inclusive and sustainable growth 19 Toward a More Competitive Business Environment Executive summary Message 1. Government regulations that restrict competition, especially in non-tradable sectors, increase the costs of key inputs for doing business and essential goods and services, reducing Mexico’s competitiveness. A coherent mechanism to remove anticompetitive and market-distortive national and sub-national regulations is needed to overcome the negative effects of limited market competition. Lack of pro-competitive regulations in such key strategic input sectors as telecommunications and air transport has negative economic externalities that translate into a costly and less efficient environment in Mexico for producers and consumers. In addition, removing foreign ownership restrictions will allow for more contestability. Message 2. Significant progress has been made in simplifying federal regulations related to the business environment. Further reforms that could improve the business environment include streamlining procedures related to electricity connectivity and new business registration (particularly at the sub- national level), improving mechanisms for contract enforcement, and reducing the costs of formal sector employment by increasing labor mobility. mexico reform agenda for inclusive and sustainable growth 20 Objective Strengthening competition and streamlining key regulations for firms are key to increasing Mexico’s compe- titiveness. Firm-level productivity and business entry for formal enterprises in Mexico are low relative to inter- national peers. Factors that hinder productivity include concentrated markets with dominant firms in strategic sectors and lack of effective pro-competition regulations, both of which increase the price of inputs and reduce the overall economy’s competitiveness. Furthermore, cumbersome business regulations hinder connectivity to electricity, registration of new businesses, and enforcement of contracts and increase the cost of formally emplo- ying workers. Key challenges Limited competition Mexico’s economic underperformance can be partly explained by concentrated markets, restrictive regula- tion, and anticompetitive behavior.1 The Central Bank of Mexico has estimated such costs at 1 percentage point of GDP growth each year. Worldwide empirical evidence confirms that anticompetitive behavior results in higher prices, inefficient allocation of resources, rent seeking, consumer welfare deadweight loss, and suboptimal economic performance in the form of adverse incentives to innovate and invest, reduced productivity, and lower output.2 Studies on the Mexican economy point out that inefficiencies in key sectors (such as telecommunications, electricity and oil) create wide spread and amplified negative externalities throughout the economy.3 Striking examples of such inefficiencies in Mexico include the telecommunications and transport sectors, discussed below. Lack of competition reinforces existing inequities by affecting low-income households disproportionally. On average, 31 percent of household spending is used to buy products and services provided by highly oligopo- listic or monopolistic markets. Such market power implies an average price premium of around 40 percent for about 7 percent of spending by Mexico’s poorest households. Higher prices reduce welfare 19.8 percent more in the poorest income decile than in the richest decile and 22.7 percent more in rural areas than in urban areas.4 Internationally, Mexico lags behind other countries in terms of indicators on market competition. Market structures in Mexican subsectors are less prone to competition: 27 percent of subsectors have only one provider (fixed line telecommunication infrastructure, oil and gas and electricity transmission and distribution, among others), compared with only 8 percent in other Organization for Economic Co-operation and Development (OECD) countries and 12 percent in other Latin America and the Caribbean (LAC) countries.5 According to the Global Competitiveness Report, Mexico ranks in the bottom quintile regarding the extent of market dominance (124/142) and the effectiveness of antimonopoly policy (120/142). Comisión Federal de Competencia (COFECO)6 is empowered to enforce competition law but must rely on other entities to implement and execute its decisions, weakening its institutional powers. COFECO pro- motes competition principles in federal, state, and municipal acts. The government retains the power to reject COFECO’s opinions but is obliged to publish its rejection. COFECO can also issue nonbinding opinions on existing laws, regulations, agreements, and other administrative acts, which must be published. According to Article 14 of the Competition Law, on request or by its own initiative COFECO may analyze the compatibility of laws, regulations, and other administrative acts adopted by states and municipalities with article 117 of the Mexican Constitution, which guarantees the free movement of people, goods, and services). COFECO’s deci- sions are reported to district and state attorneys, who ultimately put forward the relevant judiciary action. mexico reform agenda for inclusive and sustainable growth 21 Major changes to the Competition Law came externalities) will likely have spillovers that affect into force in 2011, but clear implementation rules performance and efficiency not only sectorally, but and actions are pending to ensure its effective en- also economy-wide. Such sectors, often deemed to forcement. Expanded investigative powers for CO- be strategic and to have public good characteristics, FECO, added provisions on leniency, and increased have been subject to heavy government involvement fines are powerful instruments to encourage com- and restrictive regulation, thereby preventing effecti- pliance with the law, but clear and transparent rules ve competition and ultimately discouraging foreign are needed for their application in order to increase direct investment and growth. For example, tele- predictability and transparency and mitigate busi- communications market practices have resulted in ness risks. A specialized court for regulatory matters broadband costs 45 percent higher than the OECD related to COFECO decisions has been created, but average (130 percent higher in purchasing power trained personnel on competition law and econo- parity terms10) and low penetration of service (11.3 mics are lacking. COFECO’s binding opinions on broadband connections per 100 people, compared government legislation that affect competition and with 71 for the OECD). Overall economic welfare collaboration agreements with Comision Federal de loss from the dysfunctional telecommunications Mejora Regulatoria (COFEMER)7 and Procuradu- sector are more substantial—around $129.2 billion ria Federal del Consumidor (PROFECO)8 are a step over 2005–09, or 1.8 percent of GDP a year.11 Ame- forward to integrating pro-competition principles rica Movil has earned an estimated additional $6 in regulatory policies, but further action is needed billion a year by maintaining its market dominance to render them effective. with little investment in infrastructure and minimal Several national and subnational regulations innovation.12 restrict competition in Mexico. At the national Anticompetitive practices in air transport and level restrictions on foreign ownership and the num- other infrastructure sectors that are strategic ber of firms in key sectors (such as oil, natural gas, inputs into productive sectors harm the Mexican and electricity) reduce the likelihood of entry into economy. Fares for routes to and from Mexico City key nontradable and service sectors. On a scale of are 40–80 percent higher than for comparable routes 0, no foreign ownership allowed, to 100, full foreign in Mexico, due partly to a restrictive slot allocation ownership allowed, the maximum shareholding for mechanism to manage congestion.13 In addition, Toward a more competitive business environment Mexico is 0 in electricity, 54.4 in transport, and 24 inadequate regulation of airport services resulted in in media—all below LAC and OECD averages direct costs to airlines and costs per airplane higher (between 70 and 80). According to OECD data on than the LAC average and in major LAC airports.14 the level of restrictiveness of sectoral regulations, Other important network industries restrict compe- Mexico lags significantly behind best practices in tition as well; for instance, limitations to private par- electricity, gas and telecommunications.9 Subna- ticipation in the electricity sector and lack of vertical tional regulations, for instance on the production separation between the operation of infrastructure of maize flour, tortillas, fuel retail, and licensing and the provision of railway services (transportation for ground passenger transportation, can restrict of passengers or freight). entry and facilitate cartel behavior or discriminate against entrants (see Table 1). Such regulations can raise prices and harm quality and product variety. Regulatory burden Anticompetitive regulations for professionals such as notaries also increase the cost of doing business. Mexico has made substantial progress in streamli- Even deployment of network services can be affected ning regulations for business, but some activities by subnational regulations on rights of way, boosting remain less efficient than in comparator countries, costs for network and coverage expansion, especially and sharp disparities remain between states. The for mobile operators. government’s new ambitious and comprehensive Anticompetitive regulations and distortive go- reform program to move toward a Base Cero regu- vernment interventions in Mexico’s telecommuni- lation approach has simplified many procedures and cations sector have negative spillovers. Sectors with norms, reducing costs for businesses. According to horizontal impact throughout the economy (often the 2010 World Bank Enterprise Surveys, appro- referred to as input markets and subject to network ximately 14 percent of senior management time is mexico reform agenda for inclusive and sustainable growth 22 TABLE 1. Cases of competition issues in subnational regulatory frameworks Anticompetitive regulation issued or proposed Product or service Importance (1) by subnational governments 7 percent of consumer expenditure on food and beverages. Municipal regulations: entry restrictions (incumbents participate Maize and related From a sample of 78 municipalities, in the entry process for new firms), minimum distances protect products 51 have regulations that against competition, mechanisms allow for price coordination. restrict competition, affecting 6.5 million of people. Municipal regulations: minimum distance restrictions 4 percent of total consumer Automotive fuels protect incumbents from competition. expenditure Municipal regulations: restrictions in licensing new terminals Ground passenger 4 percent of total consumer lessen competition. Consideration of local conditions transportation expenditure according to federal regulations affects entry as well. State regulations: statutory limitations in the number 30–85 percent of cost of Notaries of notaries restrict entry, minimum fees lessen registering a firm price competition for standard services. (1) Based on Instituto Nacional de Estadistica y Geografia, Documento Metodologico: Indice Nacional de Precios al Consumidor, 2010; PROFECO, Inhiben ayuntamientos competencia en tortillas, Brujula de Compra,2010; World Bank Group, Doing Business in Mexico 2009. spent dealing with the requirements of government also higher than the regional average. Faci- regulation, down from 21 percent in 2006. Yet a third litating connections can be worthwhile, as a of Mexican firms surveyed identify business licen- recent study shows that the time and cost sing and permits in general as a major constraint to to obtain an electricity connection in major doing businesses, well above the LAC average of 16 business cities are inversely correlated with percent. Variation in regulatory burden across states the electrification rate.15 Toward a more competitive business environment is substantial: the percentage of senior management time spent dealing with the requirements of gover- •• Registering a business. Few firms take nment regulation is 17 percent in Distrito Federal advantage of federal improvements in bu- and 20 percent in Coahuila, compared with 9 percent siness registration procedures, and state and in Nuevo Leon. Regulatory challenges for businesses municipal requirements remain a challenge. remain in four key areas: Although many of Mexico’s informal firms are not viable enough to warrant the costs of •• Accessing electricity. Nearly half of formalization, some high-potential firms are Mexican firms consider electricity a major deterred by the cost of the procedure. The constraint to business activity, well above the government launched the tuempresa.gob.mx regional average of 38 percent, according to portal in August 2009 to allow some com- results from World Bank Enterprise Surveys. panies to register online for name clearance The demand for electricity from a growing and incorporation. However, usage is low, population and industries is increasing, with approximately 3,000 new businesses straining both generation and transmission created since launch.16 In Distrito Federal, capacity. The number of days needed to with the highest system use, just 5–7 percent obtain a new electricity connection can of firms use the portal to register, while in exceed 30 and is longer in Distrito Federal most other states less than 1 percent do. and Estado de Mexico than elsewhere in the The system still requires a physical visit to country. Moreover, the duration of a typical a notary; few notaries use electronic tools, electrical outage (2.6 hours) for firms is and many view the system as a threat. Addi- twice the regional average, and losses due to tional bottlenecks include acquisition of an electricity outages (3.4 percent of sales) are operating license, which according to the mexico reform agenda for inclusive and sustainable growth 23 Enterprise Surveys takes 54 days, 17 percent due to rigid labor market regulations. Sur- longer than the LAC average. Furthermore, veys such as the 2011/2012 Global Com- although the majority of steps for opening petitiveness Report score Mexico poorly on a business are federal requirements, state issues related to labor market efficiency. requirements (from the Registro Público de Compared with other OECD countries, Comercio) and municipal requirements Mexico’s labor regulation is perceived to (obtaining operating licenses and public emphasize job security over employment notices of opening) remain hurdles.17 Lack creation.22 Major impediments to hiring of formal registration reduces firms’ ability workers and creating and expanding busi- to access productivity-enhancing services ness activities include restrictions on night such as finance. work and fixed-term contracts (which are prohibited for permanent tasks) and on •• Enforcing contracts. Enforcement of certain types of temporary work, including claims is costly and slow. An efficient judicial seasonal labor. Flexibility is limited for system makes it easier for firms to engage both collective and individual dismissals: in transactions and to stay in business while third-party notification is required if a awaiting the outcome of a court dispute.18 worker is dismissed, and priority rules World Bank Doing Business indicators for redundancies make workers with sig- for 2012 suggest that the cost of executing nificant tenure very difficult to dismiss. claims in Mexico is high. Although access Average severance pay for a worker with to tribunals is constitutionally protected and 1–10 years of experience can be as much free, related charges (mainly the attorney to as 22 weeks of salary, much more than in execute the claim)19 can raise the cost to 32 Brazil and Chile.23 percent of the claim total, well above the OECD average of approximately 20 per- •• Tax administration appears more compli- cent. Furthermore, there is an uncertainty cated in Mexico than in regional compara- about the likelihood of obtaining a real re- tors. The percentage of firms identifying tax turn, given the number and characteristics of administration as an obstacle to doing busi- Toward a more competitive business environment appeals and challenges to judicial decisions ness in Mexico (27 percent) is higher than the and numerous cases in which citizens refuse LAC average (23 percent). According to the to comply with court orders. Mexico requi- World Bank’s Doing Business 2012 survey, res 38 procedures to execute a contract, more a medium-size Mexican company averages than several comparator countries, with 347 hours a year on reporting taxes, far more processes related to trial and judgment and than the 186 hours in OECD countries. Tax enforcement taking relatively more time. A declaration and payment procedures have 2012 World Bank report on Insolvency and been simplified and reduced—for example, Creditor Rights Systems20 characterized the a 2010 decree eliminated the monthly de- enforcement of claims as slow, formalistic, claration of the flat-rate business tax and and subject to numerous delay tactics by the annual declaration of the value added debtors.21 One challenge is the constitu- tax—but surveys of firm employees suggest tional limitations hindering out-of-court that further simplification is possible. enforcement proceedings for security in- terests. Another source of inefficiency is the jurisdiction of commercial matters, currently shared by the federal and state judiciaries, as most commercial lawsuits filed and solved in the local jurisdiction, end up being debated and decided in the federal jurisdiction. •• Formally employing workers. The cost of formally employing workers remains high mexico reform agenda for inclusive and sustainable growth 24 Policy options A high-level commission with the mandate and ability to recommend eliminating anticom- petitive practices at the subnational level should 1. Supporting Competition be created to complement COFECO’s efforts at the national level. The experience of the Australian National Competition Commission can be useful Strengthening the effectiveness of the for the design of such a commission. To ensure the economy-wide competition policy framework commission’s effectiveness, states should commit to accept the commission’s recommendations or justify It is essential to ensure effective implementation of why they are not complying, and an incentive scheme the current Competition Law. To this end, actions should be devised to reward states that accomplish should be taken to: targets on removing restrictive market regulations. In addition, states should apply a simple standard Finalize the design of a mechanism to ensure ••  screening tool to ensure that new regulations do not that COFECO systematically assesses the impede competition and use a framework to identify potential anticompetitive effects of priority whether public interest reasons exist to issue regu- legislation and regulations under the current lations that restrain market competition. COFECO mandate on binding opinions;define a could help design both instruments. For instance, specific collaboration plan between CO- specific market regulations at the subnational level FECO, COFEMER, and PROFECO to (such as those on tortillas, fuels retail, ground pas- establish an early warning system to identify senger transportation, professionals, and network competition issues; and establish protocols infrastructure deployment) need to be revised to with key sector regulators for collaborating minimize their distortive effect. and addressing issues related to regulated conduct defense. Promoting competition in key Build expertise in competition law and ••  infrastructure sectors economics and economic regulation within Toward a more competitive business environment specialized courts in charge of dealing In the telecommunications sector pro-compe- with disputes and judicial injunctions on tition policies should be oriented to facilitate COFECO’s and other regulators’ decisions. entry in the sector and properly regulate es- sential inputs for competitors of incumbent Develop internal protocols to conduct sear- ••  companies. Greater regulator independence ches under cartel investigations, including is needed to increase the effectiveness of the the use forensic information technology telecommunications legal framework. Also, the tools, issue confidentiality guidelines to sa- intervention of the Secretary of Transport and feguard the integrity of sensitive commercial Communications should be limited to policy, and information, and increase COFECO’s staff training should be provided to the Specialized skills in cartel investigations. Court assessing COFETEL decisions. A clearer pro-competition framework where regulatory de- Develop guidelines on criteria for settle- ••  cisions are implemented will stimulate entry and ments and desist commitments following effective competition. In addition, the limitations international best practice. on foreign ownership for telecommunications companies should be loosened. Liberating and Finalize guidelines to transparently and ••  competitively allocating publicly owned spectrum predictably determine the optimum value of may stimulate entry and competition, particularly fines. if auctions limit allocations to participants by market share, as recently done. Additional cri- Update guidelines on leniency and settlements ••  teria such as expansion of network coverage to and provide specialized training on leniency rural areas could also be considered in spectrum and settlements to COFECO officials. auctions. In addition, based on the international mexico reform agenda for inclusive and sustainable growth 25 experience24 and in line with COFETEL’s Plan, and airport investments and encouraging market the following technical regulatory measures discipline to allow operators to face the opportunity should be considered: cost of their access rights. Various options, including secondary trading of slots rights, slots auctions, F inalizing ••  an integral interconnec- and congestion fees, should be assessed, taking into tion policy that includes a transparent account the characteristics of demand to minimize forward-looking cost-based methodology delay costs for passengers, increase market access, to calculate interconnection fees, quality and allow for redistribution of benefits. Current rules of service regulations for interconnection that differ from best practices should be amended services, nondiscriminatory treatment to apply economic criteria in declaring congestion, among operators that use the same in- avoid incumbents’ blocking their competitors’ entry terconnection facilities, special provisions or expansion even in non-congested schedules, for operators with significant market increase clarity and effectiveness of rules for re- power, and options to adapt current inter- moving slots rights, and set more transparent rules connection regulations to next generation for allocating slots. Additional actions to address networks. weak air transport regulations include facilitating open skies agreements that allow for the operation Developing regulations to allow infrastruc- ••  of foreign airlines and reducing foreign ownership ture sharing, roaming, unbundling and bit restrictions.25 stream access, and resale of telecommunica- tions services in order to foster competition at the retail level, particularly in the mobile 2. Streamlining Business Regulations services and broadband markets. ••  Implementing accounting separation Improving electricity connectivity regulation for operators with significant market power in order to prevent and detect The process to acquire permits for an electricity price-squeezing, cross-subsidization, and connection could be streamlined in some areas. For Toward a more competitive business environment discriminatory treatment to competitors in example, the process to acquire an excavation permit final markets. for external connection works in Mexico City could be simplified, particularly at the municipal level. Foresee regulatory reforms on interconnec- ••  Although procedures vary across municipalities, they tion and licensing to adapt to technology could be facilitated by having permit seekers go to convergence (such as capacity charges for only one site, rather to than multiple agencies, as is interconnection, interconnection of packet often the case now. Another medium-term possibi- switched networks and services, and general lity is to have the utility obtain the permit on behalf authorizations with open entry regime). of the customer. To further streamline the connec- tion process in Mexico City, a certified contractor If these measures fail to substantially increase program could screen and accredit contractors, who competition in the Mexican telecommunications would then require less scrutiny by the utility and market, consideration should be given to increase other government agencies. COFECO powers to break up companies with monopolistic power in cases where they abuse their dominant position in the market. While such Facilitating the registration powers are difficult to implement in practice, the of new businesses mere threat of being able to do so could induce more competitive behavior. Enhancing electronic tools for business regis- Measures are needed to manage airport conges- tration and increasing their use would reduce tion in Mexico City and allow for greater competi- the cost of these transactions to firms. A better tion. The goal of slot policy is to control congestion communications strategy with firms, chambers while ensuring reasonable retribution to airline of commerce, lawyers and their associations, and mexico reform agenda for inclusive and sustainable growth 26 notaries could boost use of the tuempresa.gob.mx businesses that deal with retail customers, with the electronic registration portal. The portal could be bonus of freeing courts for more serious business further enhanced by a standard set of incorpora- cases. The addition of a case manager has also tion documents that can be downloaded by simple been effective in speeding judicial proceedings firms registering through the platform, a faculty in some cities. Finally, electronic notifications of that has worked well in other countries. Enhancing claims could also increase the efficiency of judicial the portal by integrating federal, state, and muni- proceedings. cipal systems of business registration would allow firms to complete all their paperwork at reduced time and cost, as would removing the obligation to Reducing the cost of formally use notaries. Information sharing and integration employing workers between national and subnational government sys- tems in other areas, such as property registration, Supporting labor mobility through less rigid labor could enhance other aspects of the business envi- laws and reducing the transaction costs of business ronment; for example, linking property registries tax compliance could reduce the costs of creating of municipalities and the office of property titles to jobs in the formal sector. Mexico’s Federal Labor streamline property registration. Law (Ley Federal de Trabajo) could be amended to permit seasonal labor, short-term trial, and training contracts, which would likely encourage firms to Improving contract enforcement incorporate younger and less skilled workers into formal employment. Mexico could also consider Strengthening commercial dispute resolution procedures to ease restrictions on dismissals for re- could encourage new business relationships. dundancy, such as third-party notification.26 A study Mexico has been facilitating more efficient contract in India found that the decrease in informal firms enforcement through reforms to the Commercial was 25 percent larger and the gains in real output Code designed to increase the speed and certainty were 18 percent larger in states with more flexible of commercial arbitration proceedings and the employment regulations than in states with less enforcement of interim measures and arbitral flexible labor regulations.27 Toward a more competitive business environment awards. Further efficiency gains could be achieved Further streamlining the main business taxes through by adding out-of-court enforcement me- and reducing the required frequency of filing chanisms, particularly for enforcement of secured could lower the costs of formalization for high- claims as well as mechanisms of alternative dispute potential informal firms. More analysis of tax resolution in debt collection. The specialization in compliance costs is also needed—perhaps through commercial matters of some courts, in the main a rigorous survey—to understand how these costs commercial centers of the country, should also be affect different types of firms. A more inclusive considered along with assigning exclusive com- banking system to increase the convenience of petence to the federal jurisdiction on commercial cashless and especially electronic transactions and matters. Using less complicated procedures tailored improvements to the quality of government services to smaller claims and increasing the threshold of and overall transparency would also complement the value of claims permitted in small claims court improvements in the quality and efficiency of tax could also increase efficiency of claims, mostly for administration. mexico reform agenda for inclusive and sustainable growth 27 Matrix of short- and medium-term policy reform options* Reform area Short-term options Medium-term options 1. Supporting competition · Strengthen the scale and scope of advocacy · Build expertise in competition law by COFECO through binding opinions and and economics within specialized Effectively enforcing establish protocols with key sector regulators courts on competition matters. (AR) the Competition Law and relevant government bodies. (AR) · Increase COFECO’s staff skills in cartel · Develop guidelines and internal protocols investigations and provide specialized to increase the effectiveness of cartel training on leniency and settlements. (AR) enforcement, including bid rigging. (AR) · Devise an incentive mechanism to Integrating competition reward states and government bodies · Establish a high-level commission principles in national and that accomplish targets on removing to eliminate anticompetitive market subnational regulations restrictive market regulations and integrate regulations at the subnational level (LR) (HI, LF) competition policy considerations into policies and decisions. (LR) · Increase the independence of the sector regulator with respect to its line ministry. (LR) · Free up spectrum for broadband and · Remove restriction on foreign ownership. (LR) mobile services; allocate spectrum Integrating competition · Complete and enforce an integral interconnection to facilitate entry, competition, and principles in the policy (including cost model, quality of service expansion of network coverage; and telecommuni- indicators, nondiscrimination). (AR) manage number allocation in an efficient cations sector · Develop and implement pro-competition and nondiscriminatory manner. (LR) (HI, HF) regulations (infrastructure sharing, roaming, · Define regulatory reforms regarding unbundling, and resale). (LR) interconnections and licensing to adapt · Implement accounting separation regulation for to technology convergence. (AR) operators with significant market power. (AR) Toward a more competitive business environment Integrating competition principles in the · Facilitate open skies agreements and · Identify the best option to allocate airport slots. (AR) transport sector reduce foreign ownership restrictions. (LR) (LI, HF) · Remove entry and ownership restrictions that Integrating competition limit private participation (such as electricity) and principles in other introduce vertical separation between the operation network industries of the infrastructure and the provision of services (HI, LF) (such as freight and passenger railways). (LR) 2. Streamlining key regulations for business · Develop a certified contractor program by an independent body (with a · Streamline the process to obtain excavation list of certified contractors publicly Facilitating connectivity permit for external electricity connection works available) that would require less scrutiny to electricity at the Mexico City municipal level by having the by the utility and other agencies to obtain contractor visit a single site to obtain the permit.(AR) a new electricity connection. (LR) · Allow the utility obtain the excavation permit on behalf of its customer. (AR) · Streamline state and municipal · Improve and implement communications Facilitating business requirements for obtaining operating strategy for the tuempresa.gob.mx portal registration licenses and public notices of initiation and enhance its capabilities.(AR) of business operations. (AR) mexico reform agenda for inclusive and sustainable growth 28 Reform area Short-term options Medium-term options · Out-of-court enforcement proceedings should be introduced for all security interests, as well as mechanisms of alternative · Increase the limit of the value of cases allowed dispute resolution in debt collection (LR) Improving contract in small claims courts and allocate sufficient · Simplify the judicial process for enforcement resources to meet resultant demand. (AR) the enforcement of claims. (LR) · Implement electronic notifications of claims. (AR) · Promote specialized courts and consider assigning exclusive competence to the federal jurisdiction on commercial matters (LR) · Modify the Federal Labor Law (Ley Federal de Reducing the cost of Trabajo) to increase flexibility of hiring through · Conduct a rigorous survey of tax formally employing short-term trial and training contracts.(LR) compliance costs.(AR) workers · Ease restrictions on dismissals for redundancy. (LR) *LR=Legal Reform; AR=Administrative Reform. Preliminary Classification Note: For the purpose of this table, “legal reformâ€? refers to new laws or amendments to existing laws, while “administrative reformâ€? refers to secondary legislation and administrative actions. Toward a more competitive business environment mexico reform agenda for inclusive and sustainable growth 29 Notes 1 Arias and others 2010; Chiquiar and Ramos-Francia 2009. 2 See Syversen (2011) for a review of within country, cross country and panel data studies. 3 See Hanson G.H. “Why isn’t Mexico rich?â€?, Journal of Economic Literature 2010, 48/4, 987-1004; or Guerrero I., Lopez-Calva L.F., and Walton M. (2009) “The Inequality Trap and its Links to Low Growth in Mexicoâ€? in No Growth without Equity? Inequal- ity, Interests and Competition in Mexico, World Bank (Washington DC) 4 Urzua 2009. 5 World Bank 2010. The report covers 34 subsectors. OECD and LAC averages exclude Mexico. The total sample includes 15 OECD and 13 LAC countries. 6 COFECO enforces the Competition Law and promotes competition principles in the whole country, at the national and subnational levels. According to the competition framework, all entities and dependencies of federal, state, and munici- pal administration are subject to the Competition Law (Article 4). The competition framework includes typical antitrust provisions to deter anticompetitive business behavior (such as cartel agreements and abuse of dominant positions) and to apply a merger control policy that prevents economic concentrations with anticompetitive effects. In addition, COFECO can issue binding opinions under its own initiative or on request with regards to draft laws, regulations, agree- ments, and other administrative acts of general scope that might affect market competition (Article 24). 7 COFEMER promotes transparency in preparing and enforcing regulations, ensuring that they generate benefits that surpass their costs and maximize social welfare. 8 PROFECO promotes and protects consumer rights, boosts intelligent consumption, and seeks equity and legal certainty in the relationship between suppliers and consumers. 9 The latest OECD indicators of sector regulation are available at http://www.oecd.org/document/1/0,3746, en_2649_37443_2367297_1_1_1_37443,00.html 10 COFECO 2009. These costs are as of September 2011 for speeds of 2.5–15 Mbps, including line charge. 11 OECD 2012b. 12 Mircea 2012. 13 Ros 2010. Toward a more competitive business environment 14 Serebrisky 2012. 15 Geginat and Ramalho 2010. 16 Investment Climate Advisory Reform 2012. 17 World Bank 2012. 18 World Bank 2012. 19 World Bank 2012. 20 World Bank 2011. 21 Challenges related to enforcement of claims and insolvency proceedings are discussed in greater detail in Mexico Policy Note 2 on fostering sound financial sector development. 22 OECD 2011. This assessment is based on specific requirements for collective dismissal, regulation on temporary forms of employment, and protection of permanent workers against individual dismissal. 23 This issue is addressed in greater detail in Mexico Policy Note 4 on labor markets. 24 For more information on telecommunications regulation and best recommended practices, Infodev (2010) or the ICT Regulation Toolkit (www.ictregulationtoolkit.org/en/index.html). 25 For additional information that compares Mexico and other LAC countries, see Serebrisky (2012). 26 OECD 2011. 27 Sharma 2009. mexico reform agenda for inclusive and sustainable growth 30 References Arias, Javier, Oliver Azuara, Pedro Bernal, James J. Heckman, and Cajeme Villarreal. 2010. “Policies to Promote Growth and Economic Efficiency in Mexico.â€? Discussion Paper 4740. Institute for the Study of Labor, Bonn, Germany. Chiquiar, Daniel, and Manuel Ramos-Francia. 2009. “Competitiveness and Growth of the Mexican Economy.â€? Working Paper 2009-11. Banco de México, Mexico City. COFECO (Comisión Federal de Competencia, México). 2009. “Competencia y distribución del ingreso.â€? Mexico City. Geginat, C., and R. Ramalho. 2010. “Connecting Businesses to the Electrical Grid in 140 Economies.â€? Presentation at the International Conference on Infrastructure Economics and Development, January 14–15, Toulouse, France. Guerrero I., Lopez-Calva L.F., and Walton M. (2009) “The Inequality Trap and its Links to Low Growth in Mexicoâ€? in No Growth without Equity? Inequality, Interests and Competition in Mexico, World Bank (Washington DC) Hanson G.H. “Why isn’t Mexico rich?â€?, Journal of Economic Literature 2010, 48/4, 987-1004; Infodev. 2010. Telecommunications Regulation Handbook. Washington, D.C. www.infodev.org/en/Document.1057.pdf. Instituto Nacional de Estadistica y Geografia, Documento Metodologico: Indice Nacional de Precios al Consumidor, 2010 Investment Climate Advisory Reform. 2012. “Report on Tuempresa.gob.mx.â€? Unpublished memorandum. World Bank, Mircea, Valentin. 2012. “America Movil Abuse of Dominance Case Seems to be a “Happy-Endâ€? Story but Not for Everybody.â€? Kluwer Competition Law Blog, May 15. http://kluwercompetitionlawblog.com/2012/05/15/america-movil-abuse-of- dominance-case-seems-to-be-a%E2%80%9Dhappy-end%E2%80%9D-story-but-not-for-everybody/. OECD (Organisation for Economic Co-operation and Development). 2011. “Economic Survey: Mexico, 2011.â€? Paris. 2012a. “OECD Indicators on Employment Protection.â€? Paris. 2012b. OECD Review of Telecommunication Policy and Regulation in Mexico. Paris. http://dx.doi. org/10.1787/9789264060111-en. Ros, A.J. 2010. “A Competition Policy Assessment of the Domestic Airlines Sector.â€? Organisation for Economic Co-operation and Development, Paris, and Comisión Federal de Competencia, México, Mexico City.. Serebrisky, T. 2012. Airport Economics in Latin America and the Caribbean: Benchmarking, Regulation and Pricing. Washington, D.C.: World Bank. Sharma, S. 2009. “Entry Regulation, Labor Laws and Informality.â€? Working Paper. World Bank, Enterprise Analysis Unit, Wash- Toward a more competitive business environment ington, D.C. Syversen C. (2011), What Determines Productivity? Journal of Economic Literature 2011, 49:2, 326–365Urzua, C. 2009. “Efectos sobre el bienestar social de las empresas con poder de Mercado en Mexicoâ€? Finanzas Publicas 1 (1): 79–18. World Bank. 2010. Investment Across Borders 2010. Washington, D.C. 2011. “Report on the Observance of Standards and Codes: Insolvency and Creditor Rights Systems.â€? Washington, D.C. World Bank, 2009. Doing Business in Mexico 2009. Washington, D.C. World Bank. 2012. Doing Business in Mexico 2012. Washington, DC. World Economic Forum. 2011. “Global Competitiveness Report 2011-2012,â€? Geneva. mexico reform agenda for inclusive and sustainable growth 31 mexico reform agenda for inclusive and sustainable growth 33 Fostering Innovation for Productivity and Competitiveness Executive summary Message 1. Mexico can exploit better the oppor- tunities for technological progress and productivity offered by its proximity to the United States. Given the multisectoral nature of innovation, better coor- dination in policymaking, stronger mechanisms to define budgetary priorities, and greater synergies among public policy interventions is necessary. A holistic innovation strategy as used in highly innova- tive economies such as Finland could help guide such efforts. A policy of more systematic impact evalua- tions of programs related to innovation needs to be in place along with the development of the necessary capabilities to be able to implement it. Message 2. The research base needs to be stren- gthened through increased investments in public R&D, and much further collaboration needs to be encouraged between universities and the productive sector to better use existing technological capacities and deploy incremental R&D investments to move the productive sector up the value chain. Such co- llaborations could be encouraged through funding, more adequate rules on intellectual property rights and incentives at universities, and the development of specialized skills and intermediaries that facilitate technology transfer. Message 3. A policy on human resources for inno- vation should be defined that addresses challenges at various stages of human resources formation Efforts to increase the formation of advanced human resour- ces need to be sustained, with attention to enhancing the quality of domestic graduate education programs along with greater students’ participation in interna- tional programs. mexico reform agenda for inclusive and sustainable growth 34 Objective This note provides a medium-term agenda for supporting Mexico’s competitiveness by fostering greater innovation. Globalization and the dynamism of economies that compete with Mexico, particularly those in East Asia, bring a renewed urgency to Mexico’s innovation policy agenda. While the firm is at the center of innovation, empirical evidence shows that public policy can generate an external environment more conducive to innovation. The past decade has brought several policy changes and new programs, but further changes would help the country catch up with more innovative economies and move up the value chain. Given the multisectoral nature of innovation and multiplicity of programs, better coordination in policymaking, stronger mechanisms to define budgetary priorities for innovation, and greater coherence and synergies among public policy interventions are necessary. A comprehensive innovation strategy as used in highly innovative economies such as Finland could help guide such efforts. Key challenges Boosting innovation is critical to Mexico’s growth and competitiveness. Mexico’s growth, low relative to the country’s potential, has been driven mainly by accumulation in labor and capital. Over 2005–08 the contribution of total factor productivity was small and negative (–2 percent). This raises serious concerns because empirical research has shown that total factor productivity explains a substantial share of the difference in per capita income between developed and developing countries (Bosworth and Collins, 2003). According to the research, a substantial share of differences in total factor productivity are explained by technological progress or innova- tion broadly defined, meaning new combinations of existing resources (Romer 1990, and Aghion and Howitt, 2007), . Innovation can occur through organizational changes, changes in managerial practices, new methods of production, new sources of supply, development of new products, or upgrades to the quality of existing products. Technological progress can result from adopting knowledge that is globally available (“catching upâ€?) or develo- ping new knowledge. Both are relevant to Mexico, depending on the sector’s state of development. Information on Mexico’s performance with regard to a variety of indicators follows. Some caution in their interpretation is important given the challenges faced in measuring innovation as the literature points out. Intermediary indicators for technology-based innovation such as investments in research and develop- ment (R&D) and patents suggest that Mexico faces an innovation shortfall. The country’s overall investment in R&D remains low compared with countries with similar GDP per capita: 0.4 percent of GDP in 2009 (figure 1), well below other emerging markets such as Brazil (1.2 percent) and China (1.7 percent) and even farther from top innovation countries such as the Republic of Korea (3.7 percent) and Sweden (3.4 percent). Over the past decade Mexico’s private sector expenditure on R&D rose but remains low. Despite a recent increase, public expenditure on R&D as percent of GDP is barely above levels at the beginning of the last decade. In highly innovative economies R&D expenditure is driven primarily by the private sector, but the public sector is likely to play a greater role in emerging markets that are building core technological capabilities and that confront more acute market failures.1 The number of patents granted to Mexican nationals by the U.S. Patent Office has not changed much since the late 1990s and remains low; by contrast, the number of patents granted to many Organisation for Economic Co-operation and Development (OECD) countries and select emerging markets has surged.2 Between 2000 and 2008, for example, the number of patents granted to China more than tripled, and the number granted to the Republic of Korea more than doubled. Mexico’s stagnation in patenting occurred despite an increase in R&D, which could signal weak connectivity between research centers and the productive sector. mexico reform agenda for inclusive and sustainable growth 35 FIGURE 1. Research and development expenditure FIGURE 2. Management skills (Percent of GDP, most recent year available) (Most recent year available) US 3.7 Japan Germany 3.4 Sweden Canada Great Britain Australia Italy France New Zealand 1.7 Northern Irelan Mexico 1.2 Poland Portugal 0.7 0.8 Republic of Ireland 0.4 Chile Argentina Greece China Brazil ico d ey il a en a India az in re an rk ed ex Ch Ko Br l Tu Po Sw M 2.4 2.6 2.8 3 3.2 3.4 Source: UNESCO, Science and Technology Data Tables. Source: World Bank and surveys by N. Bloom. Technology licensing by firms--a mechanism competition, labor market rigidities, serious gaps to benefit from globally available technologies- in human resources, very limited financing for -also appears lower than in peer countries. startups, and—critically important—weak links According to World Bank Enterprise Surveys, between the productive sector and knowledge the percentage of Mexican firms using foreign institutions have all contributed to the shortfall. Fostering innovation for productivity and competitiveness licensed technologies is close to 10 percent, com- While various market failures justify government pared with 13 percent in Brazil and 16 percent in intervention, little information is available on the Turkey. impact of most government programs to foster The gap in non-technological inputs and innovation. These issues are further discussed forms of innovation appears less acute. A recent below. survey showed that management practices of Mexican firms—another important input to firm performance—were superior to those of Brazil The demand for innovation: need to and Chile but still below those of more advanced improve the investment climate economies (figure 2). This could result from the country’s greater connectivity with the United Mexico’s investment climate does not favor the States. Further, the quality of exports, measured demand for innovation. Competition, which has a by the price that Mexican goods command in substantial impact on firm behavior, can be an im- the United States, has been rising faster than the portant driver of innovation. Moreover, competition regional average, though it started at a below- from innovative new firms can be particularly im- average level.3 portant in achieving productivity gains. Yet Mexico’s Several factors help explain gaps in Mexico’s competition environment is less than favorable in innovation performance. Innovation is a pro- many sectors.4 The World Economic Forum ranks cess of knowledge creation and accumulation the intensity of local competition at 84 out of 142 by economic agents that depends heavily on the countries and the extent of market dominance at external environment and available resources. At 124. Restrictions on foreign ownership in key net- the center of growth and innovation is the firm, work industries are not contributing to competition and barriers to accumulation of either physical and innovation in those industries either. In addition, capital (K) or knowledge capital (A) can stimulate regulations constraining labor reallocation have or stifle innovation. Figure 3 illustrates drivers of also likely had an adverse impact on the density of innovation, on both the demand and knowledge startups and reduced existing companies’ demand for supply sides. In Mexico’s case less than adequate investment in new technologies. Broadly speaking, mexico reform agenda for inclusive and sustainable growth 36 FIGURE 3. National innovation system Innovation Supply Accumulation/Allocation Demand Universities/Thinktanks/ K The Firm Technology Extension Centers A Human Capital Barriers to Accumulation/Allocation Macro Context Quality Systems Credit Competitive Structure Process/Best Practice Dissemination Entry/Exit Barriers Trade Regime Sciencie and Technology System Business/Regulatory Climate International Marketing International Linkages Barriers to Knowledge Accumulation Entrepreneurship Market Failures (& IP) Seed/Venture Capital Rigidities (Labor etc.) Source: World Bank sta based on a framework by William Maloney, Development Research Group. universities’ rules on intellectual property rights the software industry (Prosoft 2.0), has facilitated are not incentivizing researchers to transform their the development of a public-private partnership that knowledge into innovations and collaborations with has helped overcome skills mismatch; similar part- industry as further discussed below. nerships could be replicated in other key industries.6 In addition, few universities offer entrepreneurship Fostering innovation for productivity and competitiveness training. The supply side: need to enhance Despite Mexico’s increased investment in ad- human resource development vanced human capital, the number of researchers has not caught up with its peers. The number of Over the past decade Mexico has made very im- researchers has increased about 80 percent over the portant progress in the development of its human last decade, a result of sustained government efforts resources, a critical pillar of an innovative eco- to fund training and education in technical areas. nomy, but further efforts will be necessary since it However, Mexico’s 1 researcher per 1,000 members has not closed the gaps with its peers. Quality and of the labor force in 2009 is still below that of com- quantity gaps remain at all stages of the education parator countries (1.5 in China, 1.3 in Brazil, and 2.4 system. Mexico has seen impressive growth in the in Turkey) and substantially below advanced econo- participation rate in secondary education but still mies (10 in the Republic of Korea). Moreover, the lags rates in Brazil, Chile and the OECD. Gradua- share of researchers in the private sector in Mexico tion rates for students in secondary education are (less than 40 percent in 2009) is lower than in highly low, at just 45 percent. International learning tests innovative economies (69 percent in the Republic of also point to quality problems in the basic education Korea). This limits the adoption of new technologies, system, creating a severe bottleneck to expanding solving of production issues, and development of the tertiary system.5 Enrollment in tertiary educa- new products. tion among the relevant age cohort was 27 percent The low share of international graduate in 2009, a good progress over the past decade, but students limits knowledge transfer from abroad still below the rate in Brazil (36 percent), Turkey and international integration of the Mexican (46 percent), and Chile (59 percent). The tertiary innovation system. Despite higher cultural and system also confronts quality challenges, with many linguistic obstacles, data from UNESCO indi- graduates often not meeting the skills demanded by cates that the Republic of Korea, Malaysia, and the labor market, for example skills demanded by the Thailand have more students studying in the Uni- software industry. To address this gap, Mexico First, ted States than does Mexico. The country’s share part of a larger initiative to support the growth of has hovered around 2.1-2.4 of the total. Even mexico reform agenda for inclusive and sustainable growth 37 Vietnam, with a much lower GDP per capita than In addition to investment climate issues, in- Mexico, has nearly caught up. International stu- adequate financing and other missing links are dents bring new ideas and knowledge to Mexico’s holding back the entry of higher value firms with innovation system and are a critical bridge to the the potential to contribute to Mexico’s structural global scientific and economic community once in transformation. The number of newly registered the labor force. firms is very low in Mexico at 0.6 per 1,000 workers compared with 2.4 in Brazil and 4.4 for the OECD according to the World Bank Entrepreneurship Weak links and missing agents in snapshots and 6.3 in China according to the Global Mexico’s innovation ecosystem Entrepreneurship Monitor (2010). Forming higher value firms (whether technology-based or not) is Collaborations between industry and research notoriously challenging worldwide and more so in centers have increased modestly in recent years emerging markets, which have few angel investors but remain far and few compared with the active and inadequate venture capital funding. New en- knowledge exchanges in dynamic innovation trepreneurs also face a steep learning curve, making ecosystems (figure 4). Cooperation between support structures that facilitate mentoring and industry and academia has been minimal due to networking to markets and financiers very valuable. different incentives and cultures. Public funding of A few initiatives are trying to address these gaps; science and technology programs have traditionally Nacional Financiera is fostering a venture capital not favored such collaborations, as discussed below; industry through a “fund of fundsâ€?; the Ministry initiatives to foster technology transfer have emerged of Economy is supporting incubators and business only since the mid-2000s. In addition, regulations on accelerators; and Consejo Nacional de Ciencia y Tec- intellectual property management (that is, regula- nología (CONACYT) has piloted some initiatives to tions on how to share the monetary benefits derived support the creation of new technology-based firms. Fostering innovation for productivity and competitiveness from technology transfer with researchers) of many research centers and universities has not encouraged the transfer of knowhow, and capacity for managing Diversity of science, technology, and intellectual property at these institutions has been innovation programs but incomplete very low. At the same time, skills gaps and lack of ca- information on outcomes pacity to absorb knowledge in the productive sector have constrained demand for such exchanges. Over the past decade several policy changes have been implemented to address key market failures and build the capabilities needed for innovation, FIGURE 4. University-industry collaboration, 2011 but little information is available on the impact of these initiatives. Policy changes started with the Law 5.7 on Science and Technology in 2002, and subsequent 5.52 5.4 amendments in 2009 emphasized the importance 4.53 4.2 of innovation and incorporated better incentives for 4.04 technology transfer by CONACYT’s public research centers, which has led to several new programs. Many other institutions (most prominently the Ministry of Economy) also support innovation-related activities. But not enough information is available on the per- formance and impact of these programs. Adopting existing knowledge is as important as developing new knowledge, and to address this gap, the Mexican government has deployed multi- A en l a il ico ae az in US ed Isr ex Ch Br ple programs for small and medium-size enterpri- Sw M Source: World Economic Forum, 2011 ses. Nelson and Winter (1982) point out that firms face a “bounded rationalityâ€? and often find difficulty adopting new knowledge because they do not know mexico reform agenda for inclusive and sustainable growth 38 where the frontier is. In most cases firms develop the countries with similar GDP per capita. A substantial knowledge of how to do things incrementally, and share of funding is allocated to the Sistema Nacional such knowledge then becomes routines. Routines de Investigadores, which prevented brain drain in the contribute to the day-to-day operation of the firm 1980s but rewards researchers on an individual basis but constrain the adoption of new knowledge. En- for publications, which does not facilitate today’s ne- hancing management ability to adopt and manage eds for multidisciplinary research or favor collabora- best practices and new technologies through well tion with industry or commercialization of research. targeted support can increase firm productivity CONACYT’s public research centers, a valuable dramatically, as the rigorous randomized experiment pillar of Mexico’s technological infrastructure, could conducted Bloom et al. (2011) in the textile sector also work more closely with industry, and more of illustrates.7 Aware of these difficulties, the Mexican their resources could come from competitive funding, government has several programs (for example, rather than direct budgetary transfers. More than 15 Fondo de Apoyo para la Micro, Pequeña y Mediana sectoral funds were jointly created by CONACYT Empresa) that help small and medium-size enterpri- and other federal institutions. Most resources were ses enhance absorptive capacity through new forms thinly spread among funds, and little information is of work organization, improved business practices, available on outcomes. modern manufacturing processes, and investment in A few initiatives encourage technology transfer worker training. and R&D-related innovation by private firms. For Program effectiveness is unclear, and the large example, CONACYT established Proinnova and number of existing programs suggests pulveri- several other programs to encourage public-private zation and overlaps. A 2011 World Bank study collaborative research. The 2009 amendments to identified 151 small and medium-size enterprise the Law of Science and Technology seek to im- programs administered by government agencies.8 prove intellectual property rights of researchers at Impact evaluations of the programs are rare in Mexi- CONACYT’s public research centers. The current Fostering innovation for productivity and competitiveness co—and are mostly qualitative and narrow in scope, challenge is to create the capabilities and a culture measuring either beneficiary satisfaction with sup- within CONACYT’s centers for greater technology port services or easily quantified program coverage transfer activities to take root. indicators. The World Bank study found positive and Federal initiatives to promote innovation at the significant impact for firms participating in a few of subnational level have not yielded all the desired the programs (a 5 percent increase in value added results due to lack of capacity. Recognizing that in one case and a 6 percent increase in employment, opportunities and needs differ across states, CONA- among other outcomes). CYT has developed initiatives (such as mixed funds Technology extension programs for the agricul- and regional funds) to foster science and technology tural sector appear to face similar challenges. These at the subnational level. Jalisco and Nuevo Leon, for programs, largely sponsored by SAGARPA, present example, have actively used these funds to support gaps in monitoring and evaluation, which weaken their innovation strategies. Government officials in the focus on results and accountability. In addition, Jalisco have involved multiple statekholders in the they could make a more efficient use of state based design of the strategy and committed public resources agricultural foundations that have successfully taken to it. Among others, the strategy seeks to encourage off during the last decade. greater industry-university collaboration, and sup- Along with these basic innovation programs for ports pre-competitive research funding, investments small and medium-size enterprises, the Mexican in research infrastructure and human capital. Many government has supported R&D, though funding of the interventions are targeted at addressing gaps has been low and needs to be reoriented to better that are specific to key local clusters (e.g., skills in respond to Mexico’s development needs. CONA- the rapidly growing software sectors, quality gaps in CYT has been the primary institution financing traditional industries). Many other states have yet to advanced human capital and research and, since the formulate a clear vision of how science and techno- mid-2000s, technology transfer (that is, commercia- logy can contribute to their development agenda and lization of research). Other public institutions, most have not been able to use the mixed funds as effec- importantly Pemex, also have research funds. Overall tively. Similarly, proposals submitted to the regional public funding for R&D has been low compared with funds have been suboptimal. mexico reform agenda for inclusive and sustainable growth 39 Policy options ones, to move into higher value added activities. The country’s huge array of programs suggests that Mexico needs a more coherent framework to orient Enhancing policymaking resources more strategically and avoid program coordination and governance overlap. The lack of information on budgets, acti- vities, and beneficiaries points to a need for better Given the multisectoral nature of innovation and consolidation of information on support for small multiplicity of programs, better coordination in and medium-size enterprises. Technology extension policymaking, stronger mechanisms to define programs targeted at small producers in the agri- budgetary priorities for innovation, and greater cultural sector are equally critical. Such programs coherence and synergies among public policy could also benefit from stronger monitoring and interventions are necessary. A comprehensive evaluation mechanisms that would inform program strategy developed by a high-level council could be design. State-based agricultural foundations could a useful tool to help coordinate policymaking and be more actively involved as intermediaries in these guide budgetary decisions as many other countries programs. committed to innovation (e.g. Finland since the early Much more collaboration between Mexico’s 1990s) have shown. research base and productive sector is needed. Several options are available to formulate Such collaborations are pervasive in all dynamic such a strategy. The General Council of Scientific innovation systems, whether in Israel, Sweden, Research and Technology, headed by the president or Taiwan (China). Technology transfer needs and entrusted with developing the six-year Science, to become a higher priority, supported with Technology and Innovation Program, could be appropriate financing. Funding would have a responsible for it. Previous programs emphasized market-enhancing purpose that develops missing building Mexico’s scientific and technological capa- capacities (such as technology transfer offices) and Fostering innovation for productivity and competitiveness cities but overlooked broader innovation challenges. addresses other market failures (such as coordina- The council requires a broader mandate and non- tion). However, there is scope for integrating si- governmental members who are innovation experts. milar programs—such as Innovatec, Innovapyme, Another option is the Innovation Committee, and the Innovation Technology Fund—to reduce headed by the Ministry of Economy, but it might costs and confusion to users. Programs such as not have enough seniority to lead a national policy. Magnet in Israel and similar ones sponsored by Alternatively, the president could form and lead a Tekes in Finland could be good reference points new high-level council with representatives from for collaborative programs. relevant ministries. Stronger incentives for technology transfer at The National Innovation Strategy will be public research centers and universities are also effective only if the council remains an active poli- needed. A culture of collaboration with the priva- cymaking body as other international experiences te sector—as is prevalent in universities in Israel, such as Finland have shown. It would need to Taiwan (China), and the United States—needs to define budgetary priorities for innovation annually be developed. Many universities in Europe, such and ensure that rigorous impact evaluations inform as Cambridge and Oxford, have successfully made its decision making. A secretariat (for example, in the such cultural transitions. To this end, CONACYT’s Ministry of Economy) would also be needed. core funding allocation to its public research centers could incorporate technology transfer activities as a performance parameter, career promotion for its re- Enhancing firms’ absorptive capacity and searchers could recognize patenting and other tech- linking them to Mexico’s technological base nology transfer activities. Such changes together with the new rules on intellectual property management Consolidating small and medium-size enterprise noted above could set an example for universities in support programs and greater efforts at evaluation Mexico to follow. Similar changes in funding and should be priorities. Effectively implementing well incentives by public technology institutes in Finland targeted technology extension services is crucial for (e.g., VTT) and other OECD countries could be a Mexican firms, particularly small and medium-size model for Mexico to consider. mexico reform agenda for inclusive and sustainable growth 40 Mexico’s research base can be further expanded means increasing support for research centers, and and strengthened. Every innovative economy has on the private sector side it implies boosting demand benefited from a strong science and technology for innovation. For example, Finland and Israel base. The objectives and impact of the programs show that university and industry research consortia developed to foster research must be assessed. For are effective in forming industry-connected human example, little is known of the impact of the more capital. than 15 sectoral funds created during the last decade. Enhancing the quality of graduate education Changes to programs should encourage larger scale, in Mexico needs to go hand in hand with graduate collaborative, and multidisciplinary research that can students’ participation in international programs. resolve more complex problems and should forge Mexican students’ participation in international pro- more international collaboration. CONACYT’s re- grams will bring global knowledge to Mexico’s in- search centers could use more competitive funding to dustry and public research base. Greater exposure of continuously foster excellence. Institutional funding domestic graduate programs to external assessments of 25–35 percent is a common practice in OECD is also needed. The certification process of these countries. The revised funding model would pave programs should be changed to allow for more inter- the way for further collaboration with other research national participation. Moreover, the overall system centers and the private sector. A transition plan could would benefit from an external evaluation of its own make this possible. Finally, the Sistema Nacional de evaluation processes by an international independent Investigadores system could benefit from more parti- panel formed ad hoc or through a formal structure cipation of international evaluators, bringing greater such as the European Association for Quality Assu- objectivity to the evaluation, as well as a study on rance in Higher Education. potential system reforms. Greater efforts should be made to enhance the states’ capacities to formulate their own innova- Integrating Mexico’s innovation Fostering innovation for productivity and competitiveness tion strategies so they can make better use of their system globally and removing barriers resources and benefit from programs at the federal to the demand for innovation level. The rapidly growing body of international knowledge makes it imperative to connect Mexico Enhancing human resource globally. This includes attracting international stu- management for innovation dents to Mexico; encouraging international research collaborations; and incorporating more international A policy on human resources for innovation should evaluators in large-scale research programs, the be defined to address challenges faced at each stage Sistema Nacional de Investigadores, and Mexico’s of human resources formation. The policy needs system of graduate programs. to improve the relevance and quality of curriculum and teaching methods. Further efforts are needed to address the causes of secondary school dropout and Enhancing the investment climate to enhance teaching quality. (For further discussion, see Mexico Policy Note 4 on labor markets for A stronger investment climate—and in particular inclusive growth). And mechanisms and standards a more competitive business environment and for evaluating the quality of universities need to be more flexible employment regulations—would strengthened. increase firms’ demand for innovation. A more Efforts to increase the formation of advanced competitive telecommunications sector would favor human resources need to be sustained, with expanded Internet services and lower connectivity attention to increasing the innovation system’s costs, facilitating smaller business integration into absorptive capacity. On the public sector side this more productive activities. mexico reform agenda for inclusive and sustainable growth 41 Matrix of short and medium-term policy reform options* Reform option Short-term options Medium-term options · Have the Innovation Council monitor strategy performance and advise on budgetary allocations and programs (AR) · Develop an innovation strategy to help coordinate · Regularly implement and dislose to the policymaking and guide budgetary decisions. (AR) Enhance council and the public impact evaluations · Develop medium-term plans to conduct impact policymaking of innovation-related programs. (AR) evaluations of innovation-related programs coordination and · Conduct independent evaluations of large-scale and initiate implementation of plans. (AR) governance programs and reviews of the overall performance · Enhance states’ capacities to formulate of key institutions related to innovation (such as their own innovation strategies. (AR) CONACYT and the broad innovation portfolio under the Ministry of Economy, including its small and medium-size enterprise programs). (AR) · Improve monitoring and evaluation of existing · Consolidate support programs for and new support initiatives for small and medium- small and medium-size enterprises size enterprises by improving information on based on evaluation results. (AR) program budgets, activities, and beneficiaries and · Enhance programs on technology extension services on assessment of program effectiveness. (AR) for small farmers based on evaluation results. (AR) Enhancing · Improving monitoring and evaluation of technology · Increase percentage of CONACYT’s research absorptive extension services programs for small farmers (AR) centers’ funding that comes from competitive capacity for · Improve monitoring and evaluation of funding rather than direct allocations. (AR) firms and a link various programs supporting research and · Encourage larger scale, collaborative, and Fostering innovation for productivity and competitiveness between Mexico’s examine options for integration (AR) multidisciplinary research that can resolve technological · Increase university-industry collaboration through (AR): more complex problems, including greater base and the • Targeted programs to support research international collaborations. (AR) productive sector consortia, contract research, licensing of · Continue stimulating university-industry technologies, and technology spinoffs. collaboration inter alia by providing funding • Development of technology transfer for such research consortia, and improved offices with administrative independence, incentives for researchers. (AR) a clear commercialization focus. · Conduct a study to explore reform • Greater participation of international evaluators in options of the (SNI). (AR) the Sistema Nacional de Investigadores (SNI) (AR) · Improve the relevance and quality of curriculum and teaching methods (see Mexico Policy Note 4 on labor markets for more detail). (AR) · Increase the formation of advanced human capital, · Further increase the formation of advanced Enhancing including the participation of Mexican students in human capital, including the participation human resources overseas graduate and postdoctoral programs. (AR) of Mexican students in overseas graduate at all levels · Change the certification process of domestic and post-doctoral programs.(AR) graduate programs to allow for more international participation in the evaluation process. (AR) · Conduct an external evaluation of the certification process of domestic graduate programs. (AR) *LR=Legal Reform; AR= Administrative Reform. Preliminary classification. mexico reform agenda for inclusive and sustainable growth 42 NOTES 1 The percentage of R&D expenditure that comes from the private sector is close to 72 percent in 2010 for the Republic of Korea and 60 percent in 2009 for Sweden. 2 Although an imperfect proxy for innovation outcomes, patents are one indicator of potential to commercialize R&D activities. 3 Lederman and Maloney forthcoming. 4 For further information, see Mexico Policy Note 1 on a more competitive business environment. 5 See Mexico Policy Note 4 on Labor Markets for further detail. 6 The program provides practical training in a variety of technical and managerial topics as well as English. The curricula are jointly developed between universities and the software industry. 7 Bloom and others 2011. 8 Lopez and Tan 2011. These also included programs other than technology extension services, such as programs to encourage training and conservation and improve earnings and safe working conditions for the workforce in small and medium-size enterprises. REFERENCES Aghion P. and P. Howitt (2007). Capital, innovation and growth accounting, Oxford Review of Economic Policy, volume 23, Number 1, 2007, pp. 79-93. Fostering innovation for productivity and competitiveness Bloom, N., B. Eifert, A. Mahajan, D. McKenzie, and J. Roberts. 2011. Does Management Matter? Evidence from India. Working Paper 16658. Cambridge, MA: National Bureau of Economic Research. Bosworth B. and S. Collins. 2003. The Empirics of Growth: An Update, Brookings Papers on Economic Activity, Vol. 2003, No 2, pp. 113-179 Global Entrepreneurship Monitor. 2011 Global Report. http://www.gemconsortium.org/docs/2201/gem-2011-global- report. Lederman, Daniel, and William F. Maloney. Forthcoming. Does What You Export Matter: In Search of Empirical Guidance for Industrial Policy. Washington, D.C.: World Bank. Lopez, A.G., and H.W. Tan, eds. 2011. Impact Evaluation of Small and Medium Enterprise Programs in Latin America and the Caribbean. Washington, D.C: World Bank. Nelson, R. and Winter, S.. 1982. An Evolutionary Theory of Economic Change Belknap Press Romer, P (1990), Endogenous Technological Change, Journal of Political Economy, 98, pp. 71-102. mexico reform agenda for inclusive and sustainable growth 43 mexico reform agenda for inclusive and sustainable growth 45 Labor Markets for Inclusive Growth Executive summary Message 1: Mexico has low unemployment rates (by global standards), its most skilled labor force ever, and has streamlined procedures to facilitate business development. Nonetheless, the country has a history of low labor force productivity that constrains economic growth and the well-being of its population. Message 2: Macro-economic policies in place helped mitigate the impact of the crises of 2008. However, economic recovery is occurring with limi- ted job creation and persistently higher unemploy- ment and underemployment, raising concerns of new joblessness and limited poverty reduction. Message 3: Policy options include: nd •• Promote labor market productivity a job creation by reducing labor market rigi- dity and increasing the relative benefits of formalization. y •• Create a more productive labor force b raising the level and labor market relevance of skills through a national skills strategy that recognizes labor-market skills acqui- sition throughout the life-cycle, continued reorientation of upper-secondary school toward the labor market, and portability of skills across the education, training, and labor market systems. and thus •• Improving allocative efficiency,  productivity, of the labor force by facili- tating job search and matching through integrated employment services, including unemployment insurance, and strengthening competency-based certification. mexico reform agenda for inclusive and sustainable growth 46 Objective This policy note outlines short- and medium-term policy options for addressing critical challenges affecting labor markets in Mexico, and in particular labor productivity. As labor is the main source of income for most of the population, poverty is closely linked to underemployment and low wages. Yet labor markets have played a limited role in poverty reduction in Mexico. Labor income accounted for just 22 percent of the decline in poverty in Mexico over the last decade compared with 38 percent in the rest of the region.1 Between the third quarter of 2008 and the third quarter of 2011, the labor income poverty index2 continued to decline in Brazil, Ecuador, and Peru but increased in Mexico (figure 1).3 The equivalent measure produced by CONEVAL (Consejo Nacional de Evaluación), shows the labor poverty trend to be increasing through the first quarter of 2012. Finding the right bundle of policies to improve labor productivity and the functioning of the labor markets can serve to improve economic growth and welfare outcomes. FIGURE 1. Labor income poverty index for selected Latin American countries, 2005–11 1.20 1.20 1.19 Base year = November, 2007 1.18 1.11 1.11 1.18 1.10 1.00 1.01 0.98 0.89 0.90 LIPI 0.88 0.80 0.77 0.76 0.76 0.70 0.60 0.60 0.50 February, 2005 May, 2005 August, 2005 November, 2005 February, 2006 March, 2006 April, 2006 May, 2006 June, 2006 July, 2006 August, 2006 September, 2006 October, 2006 November, 2006 December, 2006 January, 2007 February, 2007 March, 2007 April, 2007 May, 2007 June, 2007 July, 2007 August, 2007 September, 2007 October, 2007 November, 2007 December, 2007 January, 2008 February, 2008 March, 2008 April, 2008 May, 2008 June, 2008 July, 2008 August, 2008 September, 2008 October, 2008 November, 2008 December, 2008 January, 2009 February, 2009 March, 2009 April, 2009 May, 2009 June, 2009 July, 2009 August, 2009 September, 2009 October, 2009 November, 2009 December, 2009 January, 2010 February, 2010 March, 2010 April, 2010 May, 2010 June, 2010 July, 2010 August, 2010 September, 2010 October, 2010 November, 2010 December, 2010 January, 2011 February, 2011 March, 2011 April, 2011 May, 2011 June, 2011 July, 2011 August, 2011 September, 2011 October, 2011 November, 2011 December, 2011 January, 2012 Argentina - Urban Brazil - Urban Colombia - National Ecuador - National Mexico - National Peru - Urban Lima Uruguay - National The trend of Index for date. Colors shows details about country. The data is ltered on date, pline and fgt. The date lter ranges from February, 2005 to February, 2012. The pline lter keeps Extreme PL. the fgt lter keeps alfa =0. The view is ltered on Index and country. The Index lter ranges from 0.00 to 1.20 and keeps Null values. The country lter keeps multiple members. Source: Labor Database for Latin America and the Caribbean (LABLAC), World Bank and CEDLAS, 2012. Key challenges Labor productivity is low in Mexico and economic crises have played a key role in the lack of growth in pro- ductivity. Over the past 20 years, labor productivity grew 2.1 percent, as compared to a 64 percent increase in Ireland or an 82 percent increase in South Korea over the same period.4 This is partly due to economic crises that reversed gains. The 1995 crisis caused labor force productivity to fall drastically and the crisis in 2008 derailed the slow recovery that was occurring. In real terms, labor productivity in 2011 is below its 1995 level. So increases in productivity have been insufficient to offset the various crises suffered by the country. Capital accumulation has accounted for a greater share of growth than labor. mexico reform agenda for inclusive and sustainable growth 47 FIGURE 2. Decline in real wages, 2006–10 FIGURE 3. Employment by earnings relative to the minimum wage, 2006–11 Wage Index for selected workers (males age 15-to-64) 115.0 30 110.0 25 Index (Q3 2008 = 100) 105.0 20 Percentage 100.0 95.0 15 90.0 10 85.0 5 80.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 0 2006 2007 2008 2009 2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Agriculture + Low Tech Manufacturing 2005 2006 2007 2008 2009 2010 2011 Commerce Less than 1 min wage 4 per. Mov. Avg. (High Tech Manufacturing + Construction) Between 3 and 5 min wages High Tech Manufacturing + Construction Between 1 and 2 min wages 4 per. Mov. Avg. (Agriculture + Low Tech Manufacturing) More than 5 min wages Between 2 and 3 min wages 4 per. Mov. Avg. (Commerce) Source: Labor Database for Latin America and the Caribbean (LABLAC); Note: The categories “not speci edâ€? and “no incomeâ€? were excluded World Bank and CEDLAS 2012 Source: Banco de Informacion Economica, INEGI, 2012. FIGURE 4. Share of employment in the tradable and nontradable sectors, 2006–11 40 38 36 34 Percentage 32 30 28 26 24 22 20 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2005 2006 2007 2008 2009 2010 2011 Tradables Non-tradables (excluding Services) Services Note: Tradables are agriculture, manufacturing; nontradables (excluding services) are construction and commerce. It excludes the public sector. Labor markets for inclusive growth Source: Banco de Informacion Economica, INEGI, 2012. Despite economic growth in the past decade, real 3). The increase in the size of the labor force in recent wages have been falling since 2007, driven by low la- years has also created a downward pressure on wages. bor productivity, and are low by regional standards. The sectoral composition of jobs has changed By 2010 real wages had fallen to about 90 percent over the past decade, with a decline in the share of of their 2008 level (figure 2). GDP per capita is 65 employment in the tradable sectors (figure 4) and a percent lower than in the richest third of OECD cou- rise in the services sector. To some extent this can ntries, more due to low labor productivity than low be seen as the effects of the crisis of 2008. Demand labor resource utilization.5 The crisis aggravated this for exports fell and labor moved into the non- trend. The number of jobs paying below two times tradable sectors. However, this shift in employment the minimum wage rose during the crisis and these began prior to the crisis so while the crisis may have jobs now make up the largest share of jobs. Before exacerbated the shift it is not the sole cause. the crisis, jobs paying between two and three times Low productivity persists despite large gains the minimum wage were the most common (figure in school enrollment. Mexico has nearly achieved mexico reform agenda for inclusive and sustainable growth 48 universal coverage in primary and lower secondary labor market entrants are likely disproportionately school enrolment rates.6 Over the past five decades, affected. Together with inadequate skills, this helps completion rates for upper secondary education explain why youth unemployment rates are double doubled (from 21 percent among people ages 55–64 the average rate. Rigid labor regulations may prevent to 42 percent among those ages 25–34).7 Net enrol- labor markets from operating efficiently: when GDP ment in upper secondary was 53 percent in 2010.8 rises, unemployment falls less in countries with more Today, 16 percent of the economically active popu- rigid labor markets.11 The high costs of hiring and lation in Mexico has an upper secondary education firing reduce the total number of jobs in the formal or higher.9 However, school enrollment takes time to sector,12 affect the composition of the labor force translate into increased worker productivity: despite (youth and female unemployment is higher13), and impressive gains in enrollment and completion rates, constrain productivity (firms adopt less technology the average education level of the labor force only or adopt it more slowly, cannot adapt to new envi- increased by 2.1 years between 1995 and 2010, more ronments, and invest less in training, especially small than the regional average of 1.4 years but still with firms14). substantial room for improvement.10 Labor market rigidities that increase informa- lity also impede economic growth. Informal firms have little access to formal credit and formal con- Factors behind the limited job tracts, which constrains productivity improvement creation and low productivity and job generation. The “missing middleâ€? in Mexico, where firms are concentrated at the small and large Labor market rigidities increase labor costs in ends of the distribution, is one outcome of the high Mexico and may partly explain why recovery from rate of informality.15 Reducing the cost of becoming the crisis has been accompanied by only limited formal (lower social security contributions and taxes job creation. Mexico ranks 23 of 183 countries on and simplification of registration requirements) can a composite index of rigidity of employment that make it easier for firms to start up and grow.16 includes difficulty of hiring, constraints on hours, Inadequate levels of skills and the limited labor and difficulty in firing (figure 5). Its score was above market relevance of skills constrain productivity the world average and above the averages for the and economic growth. As defined by Article 45 OECD and for the newly emerging economies of of the Ley General de Educacion, skills are the set of Brazil, China, India, Russian Federation, and South knowledge, abilities, and attitudes that an individual Africa. Extremely high severance pay requirements, requires to perform effectively at the workplace. A particularly for short-term workers, play a large low-skilled workforce may inhibit economic growth role, creating strong disincentives to hiring. New because firms will be less willing to invest in more Labor markets for inclusive growth FIGURE 5. Rigidity of employment index for regions and selected countries, 2012 50.00 45.00 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 World ia & Paci c al Asia Caribbea n ica da) Asia frica OECD BRICS Mexic o Centr th Afr Cana South -Saharan A s East A Europe & a n d the E a s t & Nor a (US and u b ica ic S Amer Midd le Amer Latin North Di culty of Hiring Index (0-100) Rigidity of hours Index (0-100) Rigidity of Redundancy Index (0-100) Source: World Bank Doing Business, Employing Workers Indicators, 2012. mexico reform agenda for inclusive and sustainable growth 49 productive, high-skill technologies. Furthermore, Mexican youth are expected to complete an upper it causes society to forgo the benefits of additional secondary education, compared with the OECD productive workers, their relatively greater earnings average of 82 percent. Tertiary enrolments of 30 and tax revenues. Productivity is affected by both percent lag behind the LAC average of 37 percent.23 the quantity and quality of skills. The importance of Similarly, while Mexican students have impro- knowledge in math, language, and sciences – often ved their performance on tests of cognitive skills referred to as “cognitive skillsâ€? – is the main focus acquisition, as reflected on international tests in of Mexican schools. The role of technical skills, as science, math and reading, they still lag behind defined by abilities that are specific to a narrowly countries of a similar level of development sugges- defined occupation, is most commonly understood ting that education quality is an issue. Results from as job-relevant and is the realm of technical training the 2009 PISA test show that Mexican students schools. New research, primarily from the US and score above the LAC average. However, among the Europe, finds, however, that socio-emotional skills 14 benchmarking countries worldwide with a similar – defined as team work, communications skills, cus- GDP per capita, Mexico ranks 10th in reading and tomer relations, punctuality, honesty, etc. – are much 11th on the PISA math and science tests (figure 6), more responsible for higher wages than are cogni- that measure knowledge, the ability to apply it in tive skills and they are negatively associated with different contexts, and attitudes toward learning.24 unemployment.17 However, socio-emotional skill development is still not seen in Mexico as important for job preparation and there is not a systematic way FIGURE 6. Proficiency levels in science, math, to teach these skills. and reading among 15-year-olds, 2009 Employers report that the level and type of cognitive, technical, and socio-emotional skills Mexico 47 52 Science in the labor market do not match their demands. Similar countries 29 68 4 In the Mexico Enterprise Survey, three firms in ten OECD average 18 74 9 cited inadequate skills as an obstacle to productivity Mexico Mathematics 51 49 1 growth.18 And 43 percent of Mexican employers Similar countries 39 56 5 surveyed by Manpower cited difficulties filling vacancies, as compared to a global average of 31 per- OECD average 21 66 13 cent. Difficulties are not limited to highly specialized Mexico 40 60 0 Reading jobs; the top-10 jobs that firms in Mexico have the Similar countries 28 69 3 greatest difficulty filling include sales representatives, OECD average 18 74 8 secretaries, assistants, administrative personnel, labo- 0% 20% 40% 60% 80% 100% rers, and receptionists.19 Employers place a premium on cognitive and technical skills, but 40 percent of Labor markets for inclusive growth Below level 2 Level 2-4 Level 5 or more firms in the Mexico World Enterprise Survey iden- Source: OECD, Education at a Glance, 2011 tified socio-emotional skills as the most difficult skill set to find.20 Socio-emotional skills are increasingly critical in economies where jobs are more interactive, The institutions responsible for skills deve- as in the service sector, which is the largest sector in lopment in Mexico—schools as well as training Mexico.21 institutions—-do not fully prepare the labor force While school enrolment rates have increased with the skills required by the productive sector. significantly over the past few decades, insufficient Rates of return to education in Mexico have been labor market–related skills are still partly a result healthy and stable for several decades, with an extra of low education levels. Levels of upper secondary year of schooling raising earnings by an average of education among the working age population in 12 percent in 2010. Nonetheless, there have been Mexico are on par with Brazil at 35 percent and 41 fluctuations around this trend, especially by level of percent respectively, half the share found in Chile education.25 As depicted in figure 7, rates of return for and the OECD.22 Enrollment rates among youth tertiary have increased by approximately 24 percent ages 15–19 and 20–29 remain well below those in for males since 1992 while other levels have expe- Brazil, Chile, and the OECD. Only 45 percent of rienced significant declines in returns at times since mexico reform agenda for inclusive and sustainable growth 50 the 1990s. Notably, the largest decline in rates of Kingdom and three times more in Canada and the return has been in upper secondary education. These United States. Training tends to be concentrated rates of return are likely overestimated since dropout among workers who already have higher education, rates are still quite high among (disadvantaged) among white-collar workers and managers, and Mexican youth. In themselves, these high dropout among people who are already employed, partly rates highlight shortcomings in education quality. because succeeding in technical training requires a On average, 14.5 percent of the country’s upper se- strong cognitive and socio-emotional skills base. condary students failed to complete upper secondary Most job training (outside of formal education) is, in the 2010-2011 school year, with dropout rates appropriately provided by (and funded by) firms,. varying between 13.8 percent among general track However, much of this is less than 20 hours, is students and 20.9 percent among students of techni- classroom-based, and does not provide competency cal programs.26 Together, the relatively low returns to certification.29 upper secondary education, as compared to tertiary Mexico’s skills development institutions – education, and high dropout rates underscore the schools and training centers – have recognized need to encourage skills development at this level. these challenges and have begun to reform their policies and teaching methods to this end. Efforts have been made across all levels of education to FIGURE 7. Rates of Returns to increase the professionalization of teachers by Schooling by Level, males improving teacher training, competitively selecting 0.25 new teachers, and certifying teacher competencies. After poor results in the 2000 PISA assessment, 0.20 Mexico has been evaluating student performance through ENLACE in primary, lower secondary 0.15 and, more recently, in upper secondary school. Fur- thermore, a competency-based curriculum – which 0.10 included development of socio-emotional, cognitive, and technical skills – was introduced at the upper 0.05 secondary level (through the Reforma Integral de 0.00 la Educación Media Superior – RIEMS) and at the 1990 1995 2000 2005 2010 2015 lower secondary level. The RIEMS also introduced Primary Lower secondary a single national certificate for all secondary school Upper secondary University graduates and remedial support to vulnerable upper secondary students to reduce dropout rates. In 2010- Sources: Garcia-Moreno and Patrinos 2012. Standard regression estimates (OLS) using ENIGH 1992, 1994, 1996, 1998, 2000, 2002, 2004, 2006, 2008, 2010. 2011, almost 1.3 million scholarships were provided to upper secondary students.30 With the additional Labor markets for inclusive growth 600,000 scholarships planned under the Program for the Expansion of Upper Secondary Education There is both underinvestment in training and (Síguele) starting in 2012, overall approximately 6 in concentration of training among higher-skilled 10 young people will receive scholarships for upper workers. Especially where education quality is low secondary education.31 At the tertiary level, financial or mismatched to labor markets, such training can be resources provided to economically disadvantaged critical for developing technical and socio-emotional students increased their attendance from 5 percent skills. Enrolments rates in vocational training pro- in 2003 to 20 percent by 2011.32 And, in 2012, Mexi- grams in Mexico are half of those in Brazil and co introduced a Constitutional Reform that makes Colombia and only one-fifth of those in Turkey upper secondary education universal. But the gains and Poland, for example.27 In Mexico, 35 percent of have not yet been institutionalized and there is more industrial workers and 44 percent of services workers to do. report having received training.28 Overall, however, While skills-development institutions and workers in other OECD countries report receiving organizations are individually contributing to more training than their peers in Mexico: six times improving labor productivity, they are not suffi- more in Denmark, Switzerland, and the United ciently coordinated to create a cohesive, efficient mexico reform agenda for inclusive and sustainable growth 51 skills system. A review of the legal documents that by employers.35 As in other countries in the region, articulate Mexico’s education system, labor relations, spending on intermediation services is lower than and the organizations involved in skills development in other OECD countries, and there is a greater shows that all define “skillsâ€? and “trainingâ€? diffe- focus on programs that support startup firms or rently.33 Several institutions regulate and approve the self-employment, especially in rural areas, whereas training sector, but there is no clear division of labor most unemployment is in urban areas among those between institutions. The legal framework for skills seeking wage-employment. Furthermore, in spite development does not foresee ministerial or sectoral of significant advances by CONOCER, the system collaboration, even if some institutions have in practi- of competency-based skills certification, which can ce initiated bi-lateral dialogues. As a result, while each signal skills and improve matching, is incomplete. organization is developing strong strategies, they tend The importance of this matching system is to work separately, making it difficult for individuals particularly critical in the wake of the financial to navigate the system and access what they need crisis. The crisis’ impact on growth was deep and most. brief, however it served to delink labor force growth To maximize the effectiveness of training and and employment growth, increasing unemployment schooling changes, employment services that and underemployment (figure 8). Before the crisis, connect individuals with appropriate employment the economy was able to absorb all the growth in are key. However, existing employment services to the labor force, keeping unemployment low. In the better match skills and employment opportunities second half of 2008 and in 2009, however, a gap have inadequate scope and coverage. More than developed between labor force growth and emplo- half of Mexican workers at all education levels re- yment growth (figure 9). By the second quarter of ported finding their jobs through relatives, friends, 2010, employment growth again matched labor or acquaintances.34 This informal matching mecha- force growth, but the economy has not been able to nism, while common across the world, likely results generate enough jobs to employ all the potential new in misallocation of skills and lower productivity as workers who joined the labor force during the crisis, one’s circle of relatives and friends is unlikely to have so unemployment has risen. a broad knowledge of job opportunities. Mexico’s Mexico’s labor force has grown substantially over Servicio Nacional de Empleo serves a very small seg- the last decade, rising 18 percent since 2006, due ment of the workforce and is not commonly used to a convergence of several factors. The population FIGURE 8. GDP growth and FIGURE 9. Decoupling of labor force growth unemployment rate, 2005–11 and employment growth, 2005–11 120 10.00 7.00 Labor markets for inclusive growth 6.75 6.50 118 8.00 6.25 6.00 116 6.00 5.75 5.50 114 5.25 4.00 5.00 112 Index (2005 Q1 = 100) year-to- GDP Growth Unemployment rate 4.75 2.00 4.50 4.25 110 4.00 0.00 3.75 108 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 3.50 3.25 2.00 2005 2006 2007 2008 2009 2010 2011 3.00 106 2.75 2.50 104 4.00 2.25 GDP Growth (% change 2.00 102 6.00 1.75 wrt same Qtr of 1.50 100 previous Year) 1.25 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 8.00 1.00 Unemployment Rate 0.75 2005 2006 2007 2008 2009 2010 2011 10.00 0.50 Unemployment Rate Growth of Employment (Index) Growth of Labor Force (Index) (4 Qtr Moving Avg) Source: CONEVAL and Banco de Informacion Economica, INEGI, 2012 Source: Banco de Informacion Economica, INEGI, 2012. mexico reform agenda for inclusive and sustainable growth 52 has continued to grow faster than expected (fertility Reducing mandatory severance payments could did not fall as much as projected), and labor force also encourage job creation. Mandatory severance participation rates have risen 5 percent since 2005. payments, unlike unemployment insurance, place the Net migration to the United States, which formerly burden on individual firms and discourage formal absorbed some excess labor, dropped to zero between employment. Reducing severance pay can have a po- 2005 and 2010, a result of the impact of the crisis sitive impact on labor markets. When Spain lowered on the U.S. economy.36 The flattening of the upward severance pay requirements and social security taxes trend in enrollment among children under age 17 in in 1997 and 2001, the probability of permanent em- urban areas and the effect of the crisis on female la- ployment increased among young workers.40 Total bor force participation also affected the labor supply. employment also rose when Chile capped severance payments.41 There is a need to balance this reduction in severance costs with a comprehensive system of Policy options protection for the unemployed that should include The following short- and medium-term policy income protection as part of a broader set of emplo- actions address the challenges facing the Mexican yment services. The system would need to promote labor market—recovery with limited job creation, risk pooling and redistribution while limiting moral low productivity, high informality, and weak links hazard, perhaps through a combination of individual to poverty reduction—and focus on both supply accounts and a solidarity component. The system and demand. would need to avoid dampening the incentives of the unemployed for job search by the unemployed, for instance by keeping benefits fairly low, by limiting Reducing labor market rigidities and the amount that can be accumulated in the indivi- simultaneously improving social protection dual account, or by decreasing benefits over time. for the unemployed, such as unemployment Benefits are most effective when combined with or insurance and job-matching services, to conditioned on other services (search requirements increase the demand for labor and reduce in particular). Part of the funding for the broad set of informality employment services could come from eliminating some of the services that are now bundled within If Mexico increased the flexibility of its labor the payroll tax (such as housing and child care), as markets to levels found in the United States, its well as some of the least effective active labor market unemployment rate would be 2.4 percentage points programs. lower and less persistent.37 Reducing the uncertainty of how the labor Making hiring more flexible could boost job courts ( JCA) will resolve dismissal cases. The creation and productivity. Mexican labor laws current incentive structure does not favor the swift Labor markets for inclusive growth consider employee-employer relationships as per- resolution of labor disputes. Furthermore, the manent, with little room for any but open-ended composition of tribunals—composed of employers, contracts. The legislation further constrains con- employees, and government—often results in the tracts by restricting hours of work and nonstandard government casting the deciding vote, usually a com- work schedules.38 Contracting modalities that can promise between employer and employee interests. lower the costs of hiring workers and provide more The high level of discretion undermines transparency opportunities for formal employment would allow and creates incentives for both sides to bring cases for probationary periods, training/skill development to the court. Improving the efficiency, transparency, using self-selection contract provisions (specific and timeliness of judicial proceedings would lower age group, lower wages), fixed-term appointments, an important cost associated with termination of and seasonal variations in employment that protect employment and could boost formal employment. worker rights while allowing industries with cyclical Incentives could be introduced to encourage mutual demand to function efficiently. Legislation to allow agreement (deadlines, maximum salary caps, and for more contract modalities would need to strike a guidelines for reaching decisions), the grounds for balance between protection and flexibility, to avoid bringing a case before the JCA could be narrowed, abuse.39 and the JCA’s independence could be strengthened. mexico reform agenda for inclusive and sustainable growth 53 Collecting timely data for monitoring and evaluation the leap to higher skills and earnings, as was recently will be vital for identifying other bottlenecks. done in South Korea and Ireland.47 This strategy Replacing severance payments with unemplo- would identify the cognitive, technical, and socio- yment insurance could lower employer costs and emotional skills that the market values. Developing encourage firms to create higher productivity jobs. the mechanisms for a meaningful, continuous, and The labor code’s reliance on high severance payments actionable dialogue between public actors (ministries to provide income support during unemployment is of education, labor, the economy, and social develo- ineffective. More than half the cases before the JCA pment; state governments) and private actors (trade end in private settlements below legal mandates, associations, unions, training and education institu- legal fees absorb 30–40 percent of severance pay- tions, firms,48 and others) will help ensure that the ments,42 and many workers do not even bring suit productive sector’s needs inform the design of edu- for these reasons.43 Formal workers can draw on their cation and training programs. Such a strategy would pension savings during periods of unemployment, also need to identify, and include in the dialogue, the but this option is primarily for those in the formal appropriate service providers at each stage of the life- sector and has the negative consequence of lowering cycle.49 A full matching of skills training needs with retirement savings. Replacing mandatory severance appropriate providers will allow for the definition of payments with a well designed unemployment insu- organizational roles. Finally, the legal and institutio- rance scheme could lower the costs of employment, nal framework would need to be updated to reflect encourage firms to create higher productivity jobs,44 the focus on skills, establish roles for core actors, and better protect workers against risk, and allow for setup mechanisms for coordination.50 more effective job search.45 National or regional development strategies Adjusting social security contributions could would complement the more general skills develo- lower the costs of formality. One option would be to pment strategy. These sub-strategies would identify remove some benefits bundled together with old-age the sectors and regions that are likely to generate pension and health insurance under social security jobs in the future, so that clear investments plans for contributions and payroll taxes, such as housing and specific technical skills development can be decided. child care. How large an effect this has on emplo- This could reduce the over- and under-supply of yment will depend on the extent to which workers workers for some types of skills51 and thus boost undervalue the benefits provided through social productivity. security contributions and payroll taxes. Research Interventions that help vulnerable groups to shows this undervaluation is particularly high for acquire labor market-oriented skills will increase low income workers who are not willing to surrender social inclusion. Having the skills the labor market wages in exchange for the current benefits.46 Another needs is the best way to increase income-generating option is to create a universal system of health in- capacity and escape poverty. On the basis of a deeper surance and old-age pensions that is delinked from understanding of the main causes of dropout, espe- Labor markets for inclusive growth labor status. Again, understanding the implications cially at the upper secondary level, efforts should be for labor market incentives is critical. made to identify appropriate policies to overcome these constraints.52 For those who have already drop- ped out of formal education, training services should Aligning the skills development system be tailored to take into account the lower cognitive, with the needs of the labor market by technical, and socio-emotional skills of this group, improving institutions and programs to as well as providing other services that address the deliver labor market–relevant skills broader set of employment barriers they face. And for those who have completed secondary school, the A national strategy for building labor market–re- PRONABES student scholarship program should levant skills at appropriate periods of the life cycle be continued and expanded into a hybrid loan- would mobilize all actors around a common goal. scholarship program for less disadvantaged youth Defining the broad range of skills valued by the who are financially restricted from entering quality labor market, articulating a strategy for people to tertiary education programs. acquire those skills, and setting up institutional and Continue implementing the RIEMs, with a coordination mechanisms can help Mexico make particular emphasis on integrating the priority mexico reform agenda for inclusive and sustainable growth 54 skills identified by employers into the curriculum Facilitating job search and matching through and teaching methods in education and training comprehensive employment services institutions. The recent reforms to improve the quality and labor market orientation of education at Linking employment services with other interven- all levels, by raising the quality of basic education and tions and with the private sector can support tran- of competency-based curricula at the upper secon- sitions to the labor market. Employment services dary level, are still fragile.53 To institutionalize these include job intermediation services as well as more reforms, it is important to continue to bolster tea- intensive interventions such as guidance, counseling, cher development and certification; expand the new remedial education, and training or re-training for training to support even more teachers in modern, those with the greatest difficulties. Investing in interactive pedagogical methods; monitor classroom employment services has demonstrated impacts— success through the EXCALE and ENLACE to greater success finding a job, less informal sector improve the targeting of training; and continue to employment, and higher wages—and intermediation implement regular assessments and enhanced qua- and job counseling are among the most cost-effective lity assurance and accountability systems to boost services. teacher quality. Efforts to improve labor market–re- Combining a comprehensive set of job-oriented levant skills need to start early, and an early child services could help systematically tackle the most development system that focuses on developing binding constraints to employability, especially socio-emotional skills will reduce school dropout, for the poor. Evidence shows that a combination improve school performance, and boost labor market of training programs (that teach cognitive, technical access and productivity. and social-emotional skills), job search assistance, Support lifelong learning through greater temporary financial support (for transport and basic integration of different education streams and of maintenance), and referrals to other social services education and training systems. The integration is often a key to success—even if they might best of the upper secondary education system, that be provided by different institutions. Orientation the RIEMS has started, should expand to the and counseling can also direct people to the right larger skills-development system. The next step is training, reducing discrepancies between labor de- to ensure compatibility and integration between mand and supply.54 Finally, experience shows that it institutions that transfer skills, such as between is critical that employment services refer individuals community colleges and universities in the United to a broader set of services when needed (education, States. It will also be important to ensure portability training, scholarships, social workers, transport sub- of skills between the skills-development system and sidies, and so on). the labor market so that individuals can move easily Tools and a methodology are needed to manage between skills development in formal education and integral employment services that are closely on-the-job training. A system of competency-based linked to the productive sector. Building on the ex- Labor markets for inclusive growth certification (discussed below) is required to signal perience of the national employment service and nu- the acquisition of skills recognized by all the major merous private providers, such a model would need players. to ensure greater participation by the private sector. Multiple sectors, including the private sector, It should also have a specific component for the poor have a role in preparing people for the labor market. that links employment services to social assistance The government’s chief contributions are convening programs. Developing clear objectives and a strong stakeholders, generating and disseminating labor information system would help manage services on statistics and information about training offers, and the basis of results (services will typically be provided creating a regulatory framework to ensure quality by a range of public and private providers). Because and provide incentives. Strengthening the accredita- employment services have to be decentralized, the tion system for education and training institutions is quality of local services will influence success. also important for ensuring that training programs The national system of competency needs to be align with the skills demanded by the productive strengthened. A competency system can promote sector. Linking public funding for training programs efficient matching in labor markets by signaling to job placement or retention can encourage a focus skills across professions, regions, and jobs. A com- on results. petency system can also ease transitions between mexico reform agenda for inclusive and sustainable growth 55 the education and training systems and guide the The political and legal foundations of the com- development of curricula that are directly related to petency system also need to be stronger to promote skills in demand in the labor market. Such a system collaboration. Mexico should strengthen CONO- would also recognize skills acquired outside of for- CER, providing it with the autonomy it requires mal training programs. Currently, many employers and ensuring that its mechanisms involve all actors prefer to rely on experience or references rather than at the national and local levels (including employers, on diplomas or certificates as indicators of skills, education and training providers, and students). The because these do not indicate that skills have actually system needs to serve all workers by certifying on been acquired but are mainly evidence of attendance demand those who have acquired skills in formal or completion of training.55 The government can also education, training, or on the job. Ultimately, the promote the use of competency certification by pro- success of a competency system depends on its use by viding and funding only competency-based courses all actors, particularly the private sector, which needs (in sectors where these are sufficiently developed). to lead the effort. Labor markets for inclusive growth mexico reform agenda for inclusive and sustainable growth 56 Matrix of short and medium-term policy options* Policy area Short-term policy options Medium-term policy options Reducing labor market rigidities to increase the demand for labor and reduce informality ·Implement legal changes required to Making hiring modalities ·Build consensus on the best options expand contracting modalities (LR) more flexible for expanding hiring modalities. ·Monitor and evaluate effectiveness.(AR) ·Review previous proposals to increase the efficiency and predictability of labor courts. ·Reform labor courts.(AR, LR) Reducing the cost of ·Review international experience on labor ·Implement alternative severance pay terminating employment tribunals and labor court reforms. (with introduction of unemployment ·Propose ways to reduce the costs insurance mechanism; see below).(LR) of employment termination. ·Identify mechanisms to provide social security with ·Remove some (noninsurance) services fewer distortions (unbundling benefits, for example). from social security bundles. (LR) Reducing the cost ·Explore options to de-link old- age income ·Implement feasible option for delinking of formality support and health insurance from labor old-age income support and health status (including fiscal implications). insurance from labor status.(LR) Improving institutions and programs to deliver labor market–relevant skills ·Build consensus on skills and develop skills strategy, including as part of broader national ·Identify necessary legal adjustments Developing a national or regional development strategy. ·Propose institutional mechanisms skills strategy ·Identify specific needs of the vulnerable and for implementation (LR). program design adjustments to meet these needs ·Modernize teacher training and Review the private sector orientation of curricula. strengthen monitoring to improve Improving the quality, ·Review the design of core training teacher performance (LR). labor market orientation, programs and identify reform agenda. ·Implement changes for training and accessibility of ·Explore options to link funding for programs (including incentive skills development training to results in labor markets. mechanisms for a focus on results) (LR) through the education ·Strengthen the design of accreditation system ·Implement the accreditation system (LR) and training sectors for education and training programs ·Strengthen the early childhood development system. Strengthening and ·Identify areas where bridges need to be established expanding mechanisms to or strengthened between systems or institutions. ·Set up mechanisms to allow individuals Labor markets for inclusive growth integrate skills institutions ·Review options for mechanisms to establish to switch between systems (LR). and programs bridges and switch between systems. Facilitating job search and matching through comprehensive employment services ·Identify services needed by different population Developing an ·Develop an integral model, groups to enter the labor market. integral model of including for the vulnerable (AR). ·Identify existing services and employment services possibilities for linking them. Developing a mechanism to ·Design models, explore institutional arrangements, provide income-protection estimate costs, and explore mechanism to switch · Establish the system (LR). during unemployment from severance to unemployment insurance. ·Expand certification system to cover Strengthening the national ·Explore options to provide more autonomy all skills sets, ensuring its compatibility system of competency- to CONOCER and to increase the demand for with external labor markets based certification certification from workers and the private sector (particularly the United States) (AR) * LR= Legal Reforms; AR=Administrative Reforms, Preliminary Classification mexico reform agenda for inclusive and sustainable growth 57 Notes 1 Azevedo, Inchauste and Sanfelice 2012. 2 The index measures the ability to purchase the basic food basket with labor income. 3 World Bank 2011. 4 Centro de Investigación para el Desarrollo A.C. 2011. 5 OECD 2011d. 6 Puryear, Santibañez,and Solano 2012. 7 OECD 2011c. 8 SEP 2012 9 Based on author’s calculations using INEGI, Encuesta Nacional de Ocupación y Empleo, first trimester of 2010. 10 Author’s calculations using Barro-Lee data on population aged 25 years and more. The LAC Average is derived from average education rates of 25 Latin American countries. 11 Bertola 1990; Di Tella and MacCulloch 2005; Blanchard and Summers 1986; and Lindbeck and Snower 1989. 12 Kaplan, Sadaka, and Silva-Mendez 2008. 13 Feldmann 2009; Djankov and Ramalho 2009; and Samaniego 2010. 14 Acemoglu and Shimer 2000; Lopez-Acevedo 2002; and World Bank 2006. 15 OECD 2011b. 16 Koettl and Weber 2011. 17 Gintis 1971, Edwards 1976, Bowles and Gintis 1976 and 2002, and Bowles et al. 2001 find that the returns to schooling at- tributable to cognitive skills are rather small when compared to the effects to non-cognitive skills, with about 80 percent of the return to schooling formally assigned to non-cognitive skills. More recently, Carneiro et al. 2007 and Heckman and Rubinstein 2001 have found similar results. Non-cognitive skills also affect unemployment, as demonstrated by Anger and Heineck 2006 and Lindqvist and Vestman 2011. 18 Data from the 2010 World Bank Enterprise Survey for Mexico. 19 The share of firms reporting difficulties is also high in many other Latin American countries, including Argentina, Brazil, Colombia, Costa Rica, Guatemala, Panama, and Peru. Manpower 2010. 20 Authors calculations from 2010 World Bank Enterprise Survey for Mexico. 21 The demand for, and shortage of, socio-emotional skills are observed by employers across the world, in countries as diverse as India, North Africa (8 countries surveyed), Vietnam, Botswana, the Caribbean, and Tonga (Bassi, Busso, Urzua, and Vargas 2012, Blom and Hobbs 2008, Blom and Saeki 2011, Castro, Yamada, and Arias 2011, Di Gropello 2010, and IFC 2010). See also OECD and Statistics Canada 2011; Brunello and Schlotter 2011; Carneiro and Heckman 2003; World Bank 2009 and 2011; OECD 2007 and 2011c. 22 OECD 2011e, table A1.2a. The share of 25 -64 year olds with at least upper secondary education is 69 percent for Chile, Labor markets for inclusive growth and 73 percent for OECD countries on average. 23 An estimated 2.1 million 15-18 years-old are not studying nor working (about 22 percent of that age group), many of which have not completed primary schools. Cardenas, de Hoyos and Szekely 2011. 24 The 14 benchmarking countries include Argentina, Brazil, Chile, Croatia, Estonia, Hungary, Latvia, Lithuania, Mexico, Poland, Romania, Russian Federation, Trinidad and Tobago, and Turkey. 25 Garcia-Moreno and Patrinos 2012. 26 SEP 2011 27 Puryear, Santibañez,and Solano 2012 28 Author’s calculations from the 2009 ENOE. 29 Villaseñor 2012. 30 These were provided predominantly under Oportunidades and the Programa de Becas de Educación Media Superior , and represent an increase of 77 and 40 percent for these programs, respectively, since 2006-2007. 31 Presidencia de la República Mexicana 2012. 32 Programa Nacional de Becas para la Educación Superior—PRONABES. 33 For example, the General Law of Education uses interchangeably the concepts of knowledge, abilities, capacities and/or skills, when dealing with training and education contents (Articles 45 and 47). In the Federal Labor Law, training refers to mexico reform agenda for inclusive and sustainable growth 58 acquiring knowledge and abilities, without a competence-based approach (Article 153). Only the regulatory framework of CONOCER uses the concept of labor competences, which includes knowledge, abilities, skills and attitudes (Article 1). Both laws regulate the registry, approval and/or delivery of training services in Mexico, and the creation of different types of training commissions, which purpose is not clear. 34 ENOE 2011. 35 Villaseñor 2012. 36 Cohn, D., A. Gonzalez-Barrera and J. Passel, 2012.2012. 37 Based on the methodology of Di Tella and MacCulloch 2005 using data from the World Bank (various years) and Fraser Institute 2012. These scenarios compare Mexico with OECD countries over 2000–10. Over this period, the mean labor market flexibility index (as defined by the Fraser Institute 2012 using data from the World Bank, the World Economic Forum, and the Institute for Strategic Studies) for Mexico was 53.2 on 0–100 scale, where 0 is very rigid and 100 is very flexible. The mean labor market index was 88.1 for the United States, 37.1 for Germany, and 55.7 for Chile. 38 Articles 5 and 123 of the 1917 Constitution provide for a maximum of 8 hours of daytime work, 7 hours of night shift work, and overtime premiums of 100 percent. 39 Spain’s 1984 reform, which expanded the use of temporary contracts, resulted in a segmented labor market that reduced efficiency and equity (Dolado, García-Serrano, and Jimeno 2002; Feldmann 2009; Bank of Spain 2009). 40 Kugler, Jimeno-Serrano, and Hernanz 2003. 41 Pages and Montenegro 1999. 42 Kaplan, Sadaka, and Silva-Mendez 2008. 43 Dávila Capalleja 1997 and Kaplan and Sadka 2004. 44 Acemoglu and Shimer 2000. 45 Hopenhayn and Nicoloni 1997. 46 There is evidence in Mexico that some segment of the workforce undervalues benefits (Levy 2008; Cunningham and Maloney 2001). Reviewing the social security system is beyond the scope of this note, but see Mexico Policy Note 5 on social protection for recommendations. 47 Villaseñor 2012. 48 Many enterprises organize or contract training programs, especially among larger firms (84 percent of firms with more than 100 employees, 71 percent of firms with 31–100 employees, 53 percent of firms with 11–30 employees, and 39 percent of firms with 6–10 employees, according to World Bank Enterprise Surveys). According to the 2009 ENOE, half of the training in the industrial and services sectors is provided by the firm, a colleague or supervisor. 49 For example, the most fundamental socio-emotional skills for the labor market – impulse control, working with others, for example – are best taught in pre-school and in the home, reading and numeracy are best taught in primary educa- tion, and firm-specific skills are best learned on the job. 50 These include the Federal Labor Law, the General Education Law, and the Organic Law of the Federal Public Administra- tion, as well as other legal documents such as the Partnership for Education Quality and the Comprehensive Reform of Labor markets for inclusive growth Upper-Middle School. 51 Many graduates do not hold jobs that match their skills, as is the case for about 40 percent of those with industrial, electrical, electromechanical, and computer science training are in jobs that do not match their skills. This is also the case for 45–50 percent of those who studied management, marketing, or economics (ENOE 2009). 52 The 2010 survey of dropouts at the upper secondary level undertaken by the Secretaría de Educación Pública is an important source for this. According to Bravo 2009, 34 percent of dropouts cited economic conditions, 29 percent cited family reasons such as childbirth, and 11 percent cited a perception that studies are too difficult. 53 Defined in the Integral Upper Secondary Education Reform of 2007. 54 In most countries, student preference remains the main driver of educational choices, and better career guidance in support of individual choices could play an important role in reducing discrepancies in supply and demand of workers by field of study (about two in five overqualified OECD workers are employed in a job that is unrelated to their field of study; OECD 2011a). 55 Less than a third of workers were certified or received a record of their skills after their last training in the industry and service sectors. ENOE 2009. mexico reform agenda for inclusive and sustainable growth 59 References Acemoglu, D., and R. 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EdStats database. Washington, DC. http://go.worldbank.org/ITABCOGIV1. ———. 2011. “On the Edge of Uncertainty: Poverty Reduction in Latin America and the Caribbean during the Great Reces- sion and Beyond.â€? LCSPP Poverty and Labor Brief, 3, Washington, DC. ———. Various years. World Development Indicators database. Washington, DC. mexico reform agenda for inclusive and sustainable growth 61 mexico reform agenda for inclusive and sustainable growth 63 Promoting an Integral Social Protection System Executive summary Message 1. Despite much recent progress, Mexico’s social protection system faces equity and efficiency challenges. The social protection system comprises social security (insurance) regimes, social assistance programs, and labor market interventions. Pending challenges include system fragmentation, program design weaknesses, regressiveness, and coverage gaps. Message 2. Further reforms are needed to build on the gains achieved and effectively reduce inequities and inefficiencies in order to achieve an integral social protection system that provides protection to all from income shocks, helps smooth con- sumption over the life cycle, and promotes greater human development. To improve the design and targeting of interventions, Mexico could consider actions to strengthen the performance of health insu- rance schemes, Oportunidades, and some of its other core programs. To close gaps in coverage, Mexico could strengthen or create interventions that improve labor market outcomes, especially among youth and the urban poor; provide old-age income security and services for the elderly poor; and mitigate the impact of disasters and crises. And, to promote an integral social protection system that articulates policies and programs, Mexico could develop a unified registry of beneficiaries or interoperable information systems, increase functional integration across health insu- rance schemes, improve coherence and compatibility across programs, and establish institutional arrange- ments for better coordination. mexico reform agenda for inclusive and sustainable growth 64 Objective This note reviews the challenges in Mexico’s social protection system and possible options to achieve an integral and effective system that is more than the sum of its parts. Mexico’s social protection system includes contributory social security schemes, social assistance programs, and labor market programs. The contributory social security schemes offer pensions and health insurance to formal sector workers to protect against income shocks and help smooth consumption over the life cycle. The recent noncontributory Social Protection System in Health (SPSH) provides health insurance to people not covered by formal schemes. To prevent poverty and promote greater human development, Mexico has several social assistance interventions, including Oportuni- dades, a conditional cash transfer program for the chronically poor, and 70 y Más, a noncontributory old-age income-support program. Finally, the social protection system also includes several labor market interventions that promote employability, facilitate job matching, and protect workers against economic shocks. This note reviews the progress achieved so far by Mexico’s social protection system and its remaining challenges to achieve an integrated system that provides effective protection to all Mexicans from income shocks, that helps them smooth consumption over the life cycle and promotes greater human development. Key challenges Despite recent progress, the social protection system faces equity and efficiency challenges Major reforms over the last two decades—establishing Oportunidades, Seguro Popular, and El Consejo Nacional de Evaluación de la Política de Desarrollo Social (CONEVAL)—have improved the coverage and effectiveness of the social protection system. A critical reform in the late 1990s was the creation of the conditional cash transfer program Oportunidades (originally called Progresa) to replace general food subsidies. This social assistance program aims at breaking the intergenerational transmission of poverty by providing 5.7 million families with a cash transfer when they comply with their co-responsibilities in terms of investments in their children’s human capital; and in parallel the Government provides basic health, nutrition and education services. The program has increased poor households’ consumption, school attendance, and use of health services. Oportunidades is highly progressive, and simulations suggest that transfers from the program result in a reduction of extreme poverty by 3.4 percentage points in 2010, with a particularly strong impact in rural areas (reducing poverty 9.6 percentage points). Because of its demonstrated impacts on health, nutrition, and education, the program has served as a model for numerous countries in the region and beyond.1 Another major reform was the creation of a health insurance, Seguro Popular, for people not covered by the social security regimes. A 2003 reform of the General Health Law institutionalized Seguro Popular, the main pillar of the noncontributory Social Protection System in Health (SPSH). It replaced the public health system’s historical budgets, which were linked mainly to preexisting infrastructure and personnel, with actuarially calcu- lated insurance premiums and replaced user fees with contributions based on household ability to pay (though in practice few affiliates contribute). This reform substantially increased public health expenditure—from 2.6 percent of GDP in 2006 to 3.1 percent in 2010, still low compared with other countries in the region and the OECD—and reduced the differential in public expenditure between those covered by formal insurance schemes and the uninsured from 2.2. to 1.5. The program expanded rapidly to cover virtually all its target population, about 51.8 million people by the end of 2011, becoming one of the world’s largest subsidized health insurance programs targeted to people outside the formal sector. Seguro Popular increased use among its affiliates 5 percentage points, decreased out-of-pocket expenditure 25 percent, and reduced the incidence of catastrophic health expenditure slightly more than 15 percent.2 mexico reform agenda for inclusive and sustainable growth 65 Progress has also been made in putting in place regimes Régimen de Jubilaciones y Pensiones and Luz y some of the legal, institutional, and operational Fuerza del Centro.5 elements required for an integral system. In parti- In labor markets multiple programs overlap and cular, the 2004 Social Development Law established are duplicative. For example, there are 63 federal a legal framework for social protection, defining its programs and actions in seven federal entities aimed contours and associated social rights. It also set up at promoting income-generation and economic well- the CONEVAL, which was instrumental in defining being, and at least 10 provide micro-credits. Many and measuring multidimensional poverty, setting up have the same objectives and target populations guidance and criteria for targeting of interventions, (mostly indigenous and rural citizens). The large and putting in place elements for greater results- number of programs directed at similar dimensions based management through its monitoring and of poverty suggests some dispersion and highlights evaluation system. the challenge of coordination. State and municipal Despite these significant reforms, the social interventions likely add to duplication and overlap.6 protection system still faces challenges: frag- Some fragmentation of the social protection mentation, design and targeting weaknesses, and system in Mexico stems from the design and finan- coverage gaps. cing of interventions. As discussed above, services vary across contributory and noncontributory regi- mes (range of health services, risks covered, bundle Fragmented social protection system of benefits, and the like). Contributory programs are (at least partly) funded from contributions In health insurance, multiple contributory sche- from formal sector workers, while noncontributory mes and the SPSH function in parallel with little programs are typically financed largely from general coordination. Each scheme has its own funding government resources. This dichotomy can create sources, insurance pools, administration structures, incentives for individuals to adjust their labor market financial reserves, and service provider networks, behavior, which can affect their individual coverage, resulting in large inefficiencies. There is very little the financing and risk-pooling of the system, and functional integration and coordination across these labor markets.7 subsystems  because affiliates are limited to services provided by their scheme’s own network. In 2011 Promoting an integral social protection system administration and insurance costs accounted for Weaknesses in program design and targeting an estimated 10.8 percent of total expenditure on health, the highest in the OECD.3 Mexico has very strong experience in targeting Fragmentation can result in unequal access programs to the vulnerable, but some programs when insurance subsystems offer different packa- still disproportionately benefit the wealthiest while ges of services. For example, despite recent improve- absorbing an important share of resources. While ments, the health insurance schemes of the Instituto Oportunidades and Seguro Popular are amongst the Mexicano del Seguro Social (IMSS) and the Instituto most progressive interventions, and despite overall de Seguridad y Servicios Sociales de los Trabajadores del improvements in the targeting of social spending over Estado (ISSSTE) cover services at all levels of care, the past few years, several programs benefit richer while the SPSH covers only a small set of highly households disproportionately. In particular, general complex health services.4 Service quality also varies subsidies for liquid gas, gasoline, and residential elec- across schemes. For example, in 2000, before the tricity, initially put in place to protect the poor from introduction of the SPSH, the maternal mortality increases in energy prices, benefit the richest house- ratio was nearly three times higher among women holds most (figure 1). Other programs are regressive with access only to the public health care service by design; for example, the Employment Subsidy system than among women with contributory social Program (Subsidio para el Empleo), which covers only health insurance. Among old-age income-security formal workers (less than 5 percent of the subsidies programs, the average benefits or annuities also vary goes to the poorest household decile). Even many tar- widely across schemes, ranging from 500 Mexican geted programs do not reach the poorest. Programs pesos a month for beneficiaries of 70 y Más to 17,500 targeted to the indigenous population and programs Mexican pesos for beneficiaries of the contributory of the Social Development Ministry (SEDESOL) mexico reform agenda for inclusive and sustainable growth 66 FIGURE 1. Incidence of major subsidies and mentioned in Mexico Policy Note on medium-term selected programs by income decile, 2010 fiscal sustainability, energy subsidies have been esti- mated at over 1.5 percent of GDP.8 35% Despite recent efforts to address inequalities in social outcomes, there remain large regional 30% variations in service provision, which tend to 25% reinforce prevailing patterns. An analysis of major 20% federal programs reveals that some cover better-off 15% municipalities and states more than they cover the most vulnerable ones. For instance, Liconsa, a nu- 10% trition program that provides milk to low-income 5% households, is less present in municipalities with a 0% higher nutrition deficit, a pattern repeated within 1 2 3 4 5 6 7 8 9 10 some States, such as in Oaxaca, where the most Oportunidades/Energético/ Seguro Popular vulnerable municipalities tend to be less covered Apoyo Alimentario Adultos Mayores (figure 2). An analysis of the federal funds trans- Subsidio Gasolina Subsidio Gas LP Gasto Fiscal (IVA) ferred to states and municipalities to perform core Subsidio Eléctrico Residencial decentralized functions, in health and education in Source: Scott 2001 particular (known as the Ramo 33 and accounting for 20–26 percent of federal expenditure), shows that not all programs are closely aligned with the depth of tend to be progressive in rural areas, but programs the issues they address. Similarly, despite the intro- of the Secretariat of Agriculture, Livestock, Rural duction of the Social Protection System in Health, Development, Fisheries, and Food (SAGARPA) access to health services “when neededâ€? remains are concentrated in richer municipalities. The most around 86 percent in some states, and the provision regressive programs account for a substantial share of of medicines included in the system’s benefit package expenditure: consumption and agricultural subsidies ranges from 43 to 88 percent. These differences can account for 47 percent of income-support programs also be found in health resource distribution and in and, with the special value added tax regimen for their intensity of use, resulting in large performance Promoting an integral social protection system selected food and medicines, they are four times variations between state health systems (Sistemas larger than all targeted programs put together. As Estatales de Salud, SESAs). 9 FIGURE 2. Coverage of Liconsa for decile of municipalities ranked by nutrition status All Mexican municipalities Municipalities in Oaxaca Decile of municipalities rankedin terms of their Decile of municipalities rankedin terms of their nutrition “carenciaâ€? and weighted by their population nutrition “carenciaâ€? and weighted by their population 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Liconsa Coverage National Average Nutrition “carenciaâ€? Liconsa Coverage Oaxaca Average Nutrition “carenciaâ€? Source: Calculations from Liconsa and CONEVAL data Source: Calculations from Liconsa and CONEVAL data mexico reform agenda for inclusive and sustainable growth 67 In addition to the inefficiencies created by the in the poorest quintile receive a pension, compared lack of functional integration across health insu- with 41 percent in the richest quintile. The low rates rance schemes, their internal organization and are due partly to the fact that less than half of lower functioning can also generate inefficiencies. For wage workers retain jobs in the formal sector for 25 instance, health insurance schemes integrate finan- years, the minimum time needed for a pension.12 cing and service provision. Together with provider The recent expansion of noncontributory programs payments mechanisms unrelated to production, this such as 70 y Más and Seguro Popular addresses some can result in inefficiencies because strategic purcha- of the gaps, but they remain insufficient to ensure sing of services (the option to decide what to buy, full protection and attention in old age. Overall, the how often and from whom)10 is precluded. The system remains highly fragmented and rigid. government, aware of this issue, has deployed impor- While some instruments can protect house- tant efforts to reorganize the systems, particularly in holds in emergencies or crises, the social protec- the case of the SPSH; however, progress has been tion system lacks the adequate panoply of mecha- limited. nisms needed to mitigate impacts. The Temporary Employment Program and Oportunidades protected beneficiaries during recent economic crises; the Coverage gaps affecting the Climate Emergency Program covered more than poor and vulnerable and those in 3 million smallholder farmers against crop losses the informal labor market related to natural disasters in 2009, increasing yields and incomes; and formal workers were allowed to Employment services, which promote employa- withdraw part of their pension savings during the bility and intermediation, have limited coverage. recent economic crisis. However, these programs The bulk of resources for active labor market policies reach only some population groups and are not suffi- and programs, broadly defined, goes to income- cient to completely mitigate crises (the Temporary generation and productive programs. Many of these Employment Program focuses mostly on rural areas, programs focus on agricultural production, where although it expanded to urban areas during the most they tend to reach large agricultural producers and recent crisis; Oportunidades is not designed to quic- have limited impact on poverty. In contrast, few kly sign up transient populations; and the Climate employment services promote greater employabi- Emergency Program does not reach the poorest). Promoting an integral social protection system lity and inclusion in the labor market (services of And they do not cover all risks; in particular indi- labor intermediation, counseling, financial aid for vidual unemployment risks (experience from Chile job search, skills upgrading or training, child care, suggests that those most likely to be affected by and the like). Such programs—including Instancias unemployment are least likely to have accumulated Infantiles, which focuses on vulnerable mothers and enough to provide for effective protection).13 single fathers—can have substantial impacts on labor More financing will be needed to close these force participation and duration. The overall distri- gaps, which will likely be exacerbated by Mexico’s bution of programs translates in greater coverage in demographic and epidemiological transitions. rural areas, while important gaps in the coverage of Even if Mexico achieves efficiency gains within employment services persist in urban and peri-urban programs, targets programs more effectively, and areas, despite increased urban poverty.11 exploits synergies across programs, filling existing In terms of old-age income security, about gaps will require greater financing, which would have 37 percent of Mexican workers contributed to a to be part of a broader fiscal reform to increase tax pension system in 2010, significantly below the re- collection capacity and alter revenue allocation, as gional average of 45 percent. While this percentage discussed in Mexico Policy Note on medium-term has increased over time, progress has been limited fiscal sustainability. The option of more systematic since the early 1990s, and contribution rates are only funding of social protection programs from general marginally higher among younger workers. The poor revenues to reduce system fragmentation and de-link have particularly low rates, with less than a tenth of services from labor status could be considered within workers in the poorest quintile contributing, compa- the context of a broader fiscal reform. In addition, red with two-thirds of workers in the richest quintile. in the medium to long term, population aging and As a result, only 7 percent of those ages 65 or older exposure to unhealthy diets, physical inactivity, and mexico reform agenda for inclusive and sustainable growth 68 tobacco use and alcohol abuse can threaten the fi- mechanism to take into account updated poverty nancial sustainability of health insurance schemes, lines and multidimensional poverty, paid better as the burden of non-communicable diseases (e.g. attention to indigenous groups, and redefined its cardiovascular diseases, diabetes, cancer, etc.) grows, recertification and exit criteria. To provide transfers and will call for a sharper focus on prevention. Lon- to isolated population groups that lack access to ger lives will also affect labor markets and incomes basic services, the government also set up the Food because people will be able to work longer, but will Support Program (PAL, Programa de Apoyo Alimen- require old-age income protection longer. tario), an unconditional transfer program operated by Oportunidades since 2009. Oportunidades has also expanded in urban areas. More generally, some of the conditions that originally motivated the program Policy options have changed, and analyses have revealed the need for greater focus on promoting the employability of beneficiaries, both in terms of greater skill acquisition 1. Improving the design and and in terms of transition to labor markets.16 As a targeting of interventions result, Oportunidades is evaluating whether to modify or add co-responsibilities, including strengthening The performance of the health insurance schemes the focus on early childhood development and pres- must continue to be strengthened. Doing so requi- chool; making health co-responsibilities more effec- res changing their organization and functioning, in- tive (taking advantage of SINOS) while reducing cluding clearly separating financing and provision, as the number of visits required, for which there is little well as provider payment mechanisms to allow stra- or no evidence of benefits; generating mechanisms tegic purchasing. Using production-based payments to promote completion of upper secondary school more would offer incentives for providers to decrease and supporting the transition from school to higher inefficiencies while improving quality, particularly education or to work. In addition, the questions of if purchasing across different schemes becomes the efficiency in urban areas, mechanisms of intervention norm. The 2003 health reform envisioned these in indigenous areas, and the quality of the services changes in the state health systems to ensure better received by beneficiaries merit further attention. management of Seguro Popular and established in- Resources and programs must be better targeted Promoting an integral social protection system centives to promote equality, technical efficiency, and to improve the progressivity and design of inter- responsiveness. These incentives included new provi- ventions. Mexico has substantially improved the der payment mechanisms that would facilitate insu- progressiveness of its social protection interventions rance portability across states and schemes, thereby over the past decade. But many programs could still allowing greater functional integration (as discussed be retargeted or eliminated, and resources could be below). In contrast to other reform objectives, there better allocated. In particular, some of the subsidies has been little progress in reforming the organization initially put in place to protect the poor—including and functioning of the state health systems,14 though energy subsidies and some tax exemptions and special some have started to purchase services from other regimes—could be eliminated and existing targeted states and social security institutions.15 Finally, the programs used to compensate the poorest. Other health system urgently needs to be reformed to better programs could be better targeted, on the basis of the respond to the increasing burden of non-communi- measures of rezago, pobreza, or carencia developed by cable diseases. This requires shifting from a system CONEVAL. This could be facilitated by the creation organized to deal with episodes of acute illnesses to a of a unique registry, as discussed below. Federal re- system focused on preventing and controlling chro- source allocation, both within federal programs and nic conditions. The creation of the SINOS (Sistema in transfers to municipalities and states, could also de Información Nominalizado de Salud) and its health better address some regional disparities in outcomes. risk management strategy (Consulta Segura) is a step This would call for allocation mechanisms related in this direction. (at least partially) to the severity of the issue they The performance of Oportunidades must also are designed to address, while providing incentives continue to be improved. Oportunidades has been for efficient service delivery and for allocation of strengthened over the years: it improved its targeting local resources.17 The systematic evaluation efforts mexico reform agenda for inclusive and sustainable growth 69 led by CONEVAL have significantly improved the such as contributions for housing funds, sports or design and implementation of some programs, and cultural facilities, and child care).18 Another action, this should be replicated for programs that still lack now under way, is the expansion of noncontributory clearly defined objectives, targets, or implementation schemes targeted to vulnerable groups. In the me- mechanisms. Clearer targets and design can increase dium term, with the population aging, Mexico could program efficiency and impact. Strengthening states’ identify needs for broader services for the elderly capacity and mandate to monitor and evaluate would in order to set up mechanisms for these services to also be critical. Stronger results orientation is impor- be available and financed as needed. In the longer tant for more effectively allocating resources based on term, building on these shorter-term actions, Mexico results on the ground, including through contracting could pursue an integrated system, within which public or private providers based on results. benefits evolve according to an individual’s condition and that provides incentives for individuals to save for old age. This system could be at least partially 2. Closing gaps in coverage by delinked from labor markets, as in Chile. strengthening or creating interventions Mechanisms are needed to mitigate the impact of disasters and crises. To protect households Effective programs are needed to improve labor against crises—whether affecting one family or a market outcomes, especially among the youth and larger group—Mexico needs to go beyond existing the urban poor. While multiple factors affect labor programs to offer a range of mechanisms adapted to market productivity and job creation beyond the different situations. Some programs would be per- scope of this note (some of which are discussed in manent (such as unemployment insurance); others Mexico Policy Note on business environment and would need to be ready for deployment at specific competition), interventions that build skills and pro- times to respond to crises. Guidelines for activation mote employability can improve outcomes in terms would also be needed, including as part of response of productivity overall and for the most vulnerable to disasters (see Mexico Policy Note on disaster groups. These policy options are presented in greater risk management). To address unemployment risks, detail in Mexico Policy Note on labor markets and Mexico could replace severance payments with a include integral employment services for the most model that combines individual accounts with a vulnerable and a national skills strategy that aims solidarity fund that pools some unemployment risks Promoting an integral social protection system to increase labor market productivity and reduce (see Mexico Policy Note on labor markets). The poverty through inclusion. In addition, social assis- design of programs such as the Temporary Employ- tance programs could better link their exit strategies ment Program should easily adapt to multiple crises, with labor market interventions and more generally which can affect population groups differently. This ensure that their beneficiaries are connected with is particularly critical in urban contexts, where fewer such interventions when appropriate, with a view programs exist and where the vulnerable cannot to promoting their income-generation capacity. In resort to subsistence farming, as initiated with the particular, as discussed above, it is important that Temporary Employment Program. Oportunidades explores options to reduce dropout among youth—promoting transition from school to college—and to broaden the range of institutions that 3. Promoting an integral social protection can verify co-responsibilities (to reflect other options system that articulates policies and for developing skills that are labor market–relevant). programs to ensure greater impact The elderly poor should be provided with old-age income security and services. To increase Creating an overarching system that ensures that coverage of the elderly with transfers sufficient to policies and programs are compatible, synergies ensure income security, existing contributory systems are exploited, services are provided in a coordina- need greater portability of services (to reflect labor ted and efficient manner, and the like is a difficult market movements), more flexibility (for instance, endeavor that remains a challenge even for coun- in the minimum number of years required to qualify tries at the cutting edge of the issue. Mexico has for benefits), and greater efficiency (by unbundling made some progress through technical coordination services that do not protect or redistribute income, of some of its core programs on the ground, and mexico reform agenda for inclusive and sustainable growth 70 institutional arrangements exist for greater consoli- different health insurance schemes but could also be dation. But the country still lacks some of the fun- a step toward a unification of these schemes if the damental tools and mechanisms to promote greater country decides to pursue that. integration. Many of these actions are complex and Coherence and compatibility across programs will require concerted efforts. should be improved. For all elements of the social A unified registry of beneficiaries or interope- protection system, it would be important to explore rable information systems should be considered. options for coordinating across interventions,20 Each program and subsystem has its own manage- including for situations when bridges should be ment information system, including the roster of established for individuals to move from program beneficiaries, functioning in parallel to the others. to program; situations when programs should refer Even within institutions, these registries are typically beneficiaries to other interventions; situations when not integrated, although some use common tools, programs could choose joint service delivery (with such as the CUIS (Cuestionario Único de Información one person or institution interacting directly with Socio-económica de Hogares, Unique Questionnaire of beneficiaries of numerous programs); situations Socio-economic Household Information) used by when portability of entitlements and services across programs in the Social Development Ministry and providers is necessary in light of the mobility of the unique identifier called CURP (Clave Única de individuals; and situations when synergies warrant Registro Poblacional) which all social programs are joint interventions. Given the federal nature of the required to use by Presidential Decree. Interoperable country, coherence and compatibility are required information systems or a unified registry of benefi- both within and across levels of government. ciaries could foster better coordination and integra- Institutional arrangements for improved coor- tion of the social protection system’s components, dination should be established. In the long term promote a national targeting system (adapted to each Mexico would benefit from defining institutional lea- program’s needs but built on the same information dership to articulate a long-term vision and strategy system) as discussed above, allow greater coordina- and guide its implementation. Only concerted efforts tion across programs (promoting referral mecha- can address the system challenges. Past attempts to nisms, sharing data on beneficiaries, encouraging articulate social assistance and income-generation portability, and facilitating shared service delivery or employment programs, including the Vivir Mejor mechanisms) as discussed below. A unified registry (Live Better) strategy in 2007, have not been fully Promoting an integral social protection system is critical for greater efficiency and targeting but will operationalized because of lack of a lead agency to require addressing complex identification issues. coordinate programs and budgets. A first step could Functional integration across health insurance be revising the legal basis for existing coordination schemes should be increased. This is critical to institutions, including the Social Cabinet, the Social ensure portability of benefits and reduce inefficien- Development Council, or the Social Development cies and inequalities. Functional integration would Commission established by the Social Development solve many weaknesses in the current health system Law, with a view to propose institutional arrange- (such as parallel delivery networks, administration ments for the social protection system. As part of structures, and the like). Contracts and payment the tools needed to orient resources efficiently and mechanisms would need to be standardized across strategically and promote synergies while avoiding health providers to allow cross-purchasing of ser- overlaps, it is also critical to continue strengthening vices, a common information system would need CONEVAL in its role of monitoring and evaluating to be established, a sector-wide investment plan the system and its components and proposing reforms, would need to be developed, and common standards in particular at the sectoral level. It is also critical to for accrediting health facilities would need to be ensure that performance evaluations are considered adopted.19 Functional integration is compatible with in the budget allocations (as started in 2011). mexico reform agenda for inclusive and sustainable growth 71 Matrix of short- and medium-term policy reform options* Reform area Short-term options Medium-term options Objective 1: Improving the design and targeting of core interventions · Evaluate progress in the state health · Separate financing and purchasing functions systems (SESAs) and the social security of health insurance schemes. (AR) schemes in separating financing and Continue to strengthen · Reform the provider payment mechanism purchasing functions and reforming the performance of the for health service delivery networks. (AR) provider payment mechanisms. (AR) health insurance schemes · Reform health care model so that it · Evaluate the effectiveness of Sistema more effectively prevents and controls de Información Nominalizado de Salud noncommunicable diseases.(AR) (SINOS) in managing health risks. (AR) · Identify mechanisms to increase Oportunidades’ focus on early childhood and preschool; Continue to improve make health co-responsibilities more the performance of · Implement changes as relevant. (AR) effective; and promote upper secondary Oportunidades school completion and transitions from school to higher education or work. (AR) · Eliminate or transform regressive programs. (AR) · Identify poorly targeted programs and propose · Design core targeting system for programs Improving the targeting closing or updated targeting mechanisms.(AR) to adapt to their objectives (AR) and design of selected · Design mechanisms to allocate · Revise federal resources interventions and the federal resources. (AR) allocation mechanism (LR) allocation of resources · Improve objectives, targets, and design of key · Implement changes to reflect revised design, programs, using CONEVAL’s assessments. (AR) exploit synergies, and limit incompatibilities. (AR) Closing gaps in coverage by strengthening or creating interventions Promoting an integral social protection system · Define options for Oportunidades to promote · Develop a national skills policy (see Mexico Improving labor market greater skills accumulation (see above). (AR) Policy Note on labor markets). (AR) outcomes, especially for · Develop an integral employment · Implement integral services for the young and urban poor services model for the vulnerable, the most vulnerable. (AR) linked to social assistance.(AR) · Strengthen existing programs by increasing · Explore options for a unified system that Providing old-age income flexibility and unbundling some services. (AR) provides incentives for saving for old age. (AR) security and services for · Finish the rollout of the targeted · Identify needs in terms of broader the vulnerable elderly noncontributory scheme(AR) services for the vulnerable elderly. (AR) · Set up an unemployment · Identify non-covered risks and options to insurance mechanism.(LR) Mitigating the impact improve functioning of programs in times · Set up a mechanism to trigger timely of emergencies or of crises (especially in urban areas). (AR) emergency response and funding. (LR) crises on households · Explore options for the design of an · Adjust operational procedures for core unemployment insurance program.(AR) programs to better respond to crises. (AR) Promoting a more integral social protection system · Develop a platform for a unified registry Developing a unified of beneficiaries, building on the Social · Migrate core programs to the unified registry or interoperable Development Ministry’s Unique Questionnaire registry and use it for targeting, information systems of Socio-economic Household Information portability and coordination. (AR) (CUIS) and international experience.(AR) mexico reform agenda for inclusive and sustainable growth 72 Reform area Short-term options Medium-term options · Design joint information systems.(AR) · Standardize contract and payment Increasing functional · Developing a sector-wide mechanisms across health providers to integration across health infrastructure plan.(AR) allow cross-purchasing of services. (AR) insurance schemes · Set up common standards for · Establish joint information systems.(AR) facility accreditation.(AR) · Explore options for coordination between programs, including joint service delivery. (AR) · Apply mechanisms for greater Improving coherence · Identify mechanisms for service portability. (AR) portability across programs. (AR) and coordination · Identify incompatibilities and · Implement coordination mechanisms across across programs synergies between programs and programs, including joint service delivery. (AR) across government levels. (LR)(AR) · Review existing legal framework and · Define institutional arrangements for a system Developing institutional assigned responsibilities of core actors. (LR) steward and make normative adjustments.(LR) arrangements for · Continue strengthening CONEVAL capacity, · Link budget allocation to needs diagnostic improved coordination including to inform resource allocation (AR) and performance evaluation.(LR) *AR: administrative reform; and LR: legal reform. Preliminary classification Promoting an integral social protection system mexico reform agenda for inclusive and sustainable growth 73 Notes 1 The program and independent researchers undertook a series of rigorous impact evaluations that demonstrated these impacts and shaped the program’s design (www.oportunidades.gob.mx/evaluacion). Simulated reduction in poverty (measured with the linea de bienestar minimo) is from Araujo and Sandoval (2012). 2 The Social Protection System in Health includes Seguro Popular, the Fund for Protection against Catastrophic Health Expenditure, Insurance for a New Generation, Strategy of Healthy Pregnancy, and other policies. See Gakidou and others (2006); Frenk and others (2006); and Bosh and others (2012). Data on coverage are from the National Commission of Social Protection in Health. 3 See Ribe, Robalino, and Walker (2010) and http://stats.oecd.org/index.aspx?DataSetCode=HEALTH_STAT. 4 As of 2012 Seguro Popular covers 284 primary and secondary interventions with 522 pharmaceutical products; the Fund against Catastrophic Health Expenditure covers 57 highly complex services; and Health Insurance for a New Generation covers 128 child care services. 5 In some states beneficiaries of noncontributory pensions also receive state-provided social pensions. See Scott (2010). 6 Extensive analysis of the inventory of programs and their progressivity is presented in CONEVAL (2011a). 7 Since the creation of the SPSH brought the services of the subsidized regime closer to those offered by IMSS; it can potentially create an incentive for firms and individuals to choose labor market informality; thereby decreasing IMSS affiliation and increasing Seguro Popular’s. In the past few years, several studies have tried to estimate this impact, mostly finding an overall impact on IMSS affiliation that is smaller than anticipated, but an impact that increases over time and that is higher in rural areas and for certain population groups. See World Bank (2012) “Mexico Social Protection System in Health and Labor Market Affiliation 8 See Coneval (2011a), Scott (2009), and the database of Centro de Estudios para el Desarrollo Rural Sustentable y la Soberania Alimentaria. 9 See Ribe, Robalino, and Walker (2012) and Busse and others (2007). 10 For an evaluation of the Programa de Estancias Infantiles, see Angeles and others (2011). Poverty in rural areas increased from 62.4 percent in 2008 to 64.9 percent in 2010 (Coneval 2012). 11 See Rofman and Oliveri (2011) and Anton, Hernandez, and Levy (2011). 12 See CONEVAL (2011); Scott (2009, 2010); Dávalos, Haddock, and Freije-Rodríguez (2011); Skoufias and Vinha (2010); De Promoting an integral social protection system Janvry and others (2006); and Fuchs and Wolff (2010). In Mexico withdrawals are limited to a maximum of 90 days of last wage every five years. In Chile those least likely to have sufficient resources include employees with short-term contracts or with frequent moves in and out of the formal labor market. For these people withdrawals further jeopardize their retirement income (Reyes et al. 2011). 13 World Bank (2012c). 14 There is a national agreement for the exchange of emergency obstetric health services across the different insurance schemes. 15 Yaschine Arroyo (2012). 16 Already, transfers for Fondo de Aportaciones para los Servicios de Salud destinados a la Persona and for other funds from the federal government to the states are discounted from the federal solidarity contribution, one of the tripartite funds transferred to states to finance Seguro Popular. This mechanism has reduced the difference in per capita expen- diture between the state receiving most and the state receiving least from five times in 2002 to four times in 2006. See Frenk and others (2006). 17 Rural day laborers and construction workers can already waive part of the contributions to services that they do not access. 18 See Ribe, Robalino, and Walker (2012); World Bank (2008); and World Bank (2012). 19 There have been examples of coordination; for instance, some states discontinued their old-age income security noncontributory programs when the federal program 70 y Más was deployed or between Seguro Popular and Oportuni- dades, but these have not been systematic. mexico reform agenda for inclusive and sustainable growth 74 References Angeles, Gustavo, Paola Gadsden, Sebastian Galiani, Paul Gertler, Andrea Herrera, Patricia Kariger, and Enrique Seira. 2011. “Evaluación de Impacto del Programa Estancias Infantiles para Apoyar a Madres Trabajadoras.â€? Centro de Investigación en Evaluación y Encuestas, Instituto Nacional de Salud Pública. Mexico. Anton, Arturo, Fausto Hernandez, and Santiago Levy. 2011. “The End of Informality in Mexico? 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Scott, John, 2009. “Who benefits from social spending in Mexico?â€?. Mimeo. Scott, John. 2010. “Subsidios agrícolas en México: ¿Quién gana y cuanto?â€? In Jonathan Fox and Libby Haight, eds., Subsidios para la desigualdad. Las políticas públicas del maíz en México a partir del Libre Comercio. Santo Cruy el Distrito Federal: CIDE and Woodrow Wilson International Center for Scholars. Scott, John, CIDE and CONEVAL. 2011. “Gasto Público para la Equidad: Del Estado excluyente hacia un Estado de Bienestar Universal.â€? Serie ¿Gastamos para Mejorar? México Evalúa Centro de Análisis de Políticas Públicas, Santa Catarina Co- yoacán el Distrito Federal. mexico reform agenda for inclusive and sustainable growth 75 Skoufias, Emmanuel; Vinha, Katja; Conroy, Hector V.. 2011. The impacts of climate variability on welfare in rural Mexico. The World Bank: Washington, D.C. Yaschine Arroyo, Iliana. 2012. “Oportunidades? Movilidad Social Intergeneracional e Impacto en Mexico.â€? Ph.D. thesis. Cole- gio de México. World Bank. (2012) “Missing in Action? - Part Two of Mexico’s 2003 Health Sector Reformâ€?. (draft) World Bank, Washington DC. World Bank (2012) “Mexico Social Protection System in Health and Financial Protection of Citizens without Social Security.â€? (draft) World Bank, Washington DC. World Bank (2008) Mexico Health Programmatic AAA: Towards Greater Equality and Efficiency through Functional Integration Concept Note. Prepared by Christoph Kurowski. The World Bank: Washington DC. Promoting an integral social protection system mexico reform agenda for inclusive and sustainable growth 76 mexico reform agenda for inclusive and sustainable growth 79 Reducing the Footprint of Growth Executive summary Message 1. With 77 percent of its population living in urban areas and producing more than 84 percent of its GDP, as well as an estimated 75 percent of its GHG emissions, Mexico needs to focus on making urban development greener, more efficient and resi- lient, and socially inclusive. This requires developing a sound urban land management system that could be the basis to: (i) increasing urban densities in search of efficiency and livability; (ii) providing the urban layouts needed to promote bus rapid transit systems and non-motorized transport; (iii) using land based financing instruments to provide infrastructure in new low-income housing developments; and (iv) integrating risk reduction policies in urban develop- ment instruments. Message 2. The estimated cost of environmental degradation in Mexico was estimated to be 6.3 per- cent of GDP in 2008. While Mexico has undertaken effective measures to control air contamination and the costs associated with it, the costs of land and water degradation due to solid and liquid wastes have been increasing at higher annual rates, harming hu- man health, the environment, and the economy. Two areas require particular attention: (i) developing inte- grated solid waste management strategies at national, state, and municipal levels; and (ii) addressing the problems posed by hundreds of contaminated sites and planning for their redevelopment as brownfields. Message 3. Energy production and consumption are the largest source of GHG emissions in Mexico, with a total share of 60%. Enhancing energy efficiency is therefore a key element in promoting low carbon de- velopment for the country. The needed policy reforms include: (i) revising energy subsidies; (ii) expanding the use of energy efficiency labels and standards for buildings, urban infrastructure, transport, and waste management; (iii) promoting energy-efficient self- sustained companies; and (iv) encouraging the par- ticipation of banks in energy efficiency retrofitting projects. mexico reform agenda for inclusive and sustainable growth 80 Objective Reducing the footprint of growth requires a focus on three key issues: •• Transforming urban areas into greener, more efficient, resilient, and socially inclusive cities, better able to capture the economic benefits associated with urbanization. •• Ensuring sound management of the brown environmental agenda to provide the conditions for con- tinued sustainable economic green growth while preventing and minimizing negative impacts and risks for human health and the environment. •• Promoting energy efficiency in housing, transport, urban infrastructure, and waste management to enhance the sustainability and competitiveness of the Mexican economy. Key challenges Urban management Urbanization is associated with economic growth and prosperity but also with negative environmental ex- ternalities. Population growth and rapid urbanization have had marked impacts on resource conservation in and around urban areas, as well as on environmental pollution. Urban areas have become major contributors of carbon emissions; cities around the world are responsible for 75 percent of all greenhouse gas emissions.1 Intensive use of built-up areas in cities leads to increased traffic congestion, air pollution, lack of affordable housing, lack of vegetation, and loss of open green space. Urbanization can also exacerbate exposure to hazards as well as social and spatial exclusion, which can in turn be associated with the prevalence of crime and violence. Urban density is a key factor in capturing the economic benefits associated with agglomeration economies and mitigating the negative externalities. Scale economies in production, movements of labor and capital, and falling transport costs can interact to produce rapid economic growth in cities. City density also has important impacts on sustainability, since it is associated with reductions in carbon footprint, greenhouse emissions, and resource intensity. Data from the 100 largest cities in the world shows the strong negative correlation between density and CO2 emissions as well as between density and per capita water consumption, electrical use, and solid waste generation. The growth pattern in Mexican cities reduces their potential to promote green urban growth. 77 percent of Mexico’s population resides in urban areas and although the pace of urbanization has slowed since the 1940s, the concentration of economic activity in certain regions continues to increase,2 to a point that the seventy largest cities produce 84 percent of the country’s GDP. A worrisome trend observed in the past thirty years is the expansion of urban areas at a much higher rate (one to seven) than the growth of population (one to two), according to a recent study conducted by SEDESOL on 10 metropolitan areas and 50 cities.3 mexico reform agenda for inclusive and sustainable growth 81 The housing sector has contributed dispropor- earthquakes, hurricanes, and floods. Although the tionately to the expansion of urban areas, through country has made important progress in: (i) res- low-density single-use large housing develop- ponding to natural disasters through the creation ments built on the outskirts of urban areas. Mexico in 1996 of the National Fund for Natural Disasters initiated a radical transformation of its housing (FONDEN) with a minimum annual allocation of sector in 2000. Aided by macroeconomic stability 0.4 percent of total programmable public expenditu- and policy reform, the country successfully increased re; and (ii) developing innovative risk financing and the supply of low-cost housing by around 1 million insurance strategy including risk transfer instruments units each year between 2006 and 2011. Most of like the catastrophic bonds issued in 2006 and 2009, these new units have occupied around 60 percent of it has been less successful in the area of prevention the land in new urban settlements. As housing de- and risk reduction. In fact, vulnerability to adverse velopers further seek to produce more housing units natural events is rising along with the expansion of (for which substantial subsidies are available) while Mexico’s cities, the growth of its population, and the reducing the cost of land (for which no financing is increased concentration of physical assets, combined available), they acquire rural land plots distant from with poor urban and land use planning. city centers. These plots are later transformed into urban land on a plot-by-plot basis. The result is a patched urban pattern that exacerbates social exclu- Brown agenda sion, with dispersed housing developments that lack adequate services. The increased distance to the city As urbanization and economic growth have stea- implies higher transport costs for new dwellers. Es- dily increased in Mexico, the brown environmental timates suggest that households in a sample of new agenda has become crucial. Issues include the developments spend as much as half of their family insufficient number of solid and hazardous waste income on transportation and allocate an average of disposal facilities; the pollution of rivers in urban two hours a day to get to and from employment or areas and of coastal environments by municipal education centers.4 This comes at a great cost—ur- sewage and industrial effluents; and serious air, wa- ban sprawl cannot be reversed, and communities are ter, and land pollution, especially in urban centers. compelled to live with the inefficiencies and costs of The estimated cost of environmental degradation this shortsighted strategy. in 2008 was approximately 6.3 percent of GDP.6 Urban sprawl has been associated with the While Mexico has taken significant policy and re- exceptional expansion of private motorized trans- lated actions in attempting to deal with the brown portation. Over 1996–2006 Mexico’s vehicle fleet agenda, present conditions clearly demonstrate the nearly tripled. Moreover, dispersed urban patterns need for improving current policies and developing make public transport systems unviable because these new policies and actions. This section addresses two depend on higher densities to become cost-effective. areas: solid and hazardous waste management and Reducing the Footprint of Growth In addition, transport is one of the largest and fastest contaminated sites. growing sectors in Mexico in terms of greenhouse Estimated municipal solid waste generation was gas emissions and energy consumption. approximately 38.3 million tons a year in 2009 and The provision of infrastructure in far way hou- continues to grow each year. It has increased appro- sing developments is extremely costly. Since 2000 ximately 16 percent since 2003,7 and while approxi- about 60 percent of the newly urbanized land has mately 87 percent of it is collected, only 64 percent is been dedicated to housing as the country strives to reportedly disposed of in either 88 sanitary landfills or reduce the housing deficit, which is estimated to 21 controlled sites.8 The 2009–2012 National Waste be around 9  million. Yet 5 million vacant houses Management Program proposed a minimum of 50 (14 percent of the total housing stock)5 have been new sanitary landfills, of which it appears that only a abandoned because they lack minimum infrastruc- few have been started. Approximately 53 percent of ture services (38 percent) or because added transport sanitary solid waste is organic material. And while costs for the household makes them unaffordable. this presents an excellent opportunity for waste-to- Poor urban and land use planning is a key factor energy projects, only a limited number of them have underlying the increase in disaster risk. Mexico is become operational. While many municipalities prone to a wide range of natural hazards, including have initiated recycling programs (primarily focused mexico reform agenda for inclusive and sustainable growth 82 on aluminum, glass, certain plastics, and paper), in include the General Law for Prevention and Integral 2008 only 3.3 percent of Mexico’s total urban waste Management of Wastes and its associated regulatory was recycled. standards (for example, Norma Oficial Mexicana Approximately 9.1 million tons a year of impro- for heavy metals and polychlorinated biphenyls). perly managed hazardous waste are reportedly ge- In 2011 the National Program for Remediation of nerated by Mexican companies. Reported estimates Contaminated Sites was established, with its main of inadequate hazardous waste disposal range from objectives being to reduce the number of contamina- 60 to 80 percent of the total produced.9 Substantial ted sites where human health and natural resources quantities of mining waste and petroleum sector are affected, reintegrate remediated contaminated si- wastes are also generated in Mexico. An additional tes into the economic cycle, and contribute to urban average daily production of special wastes of appro- renovation and the improvement of living conditions ximately 17,149 tons is reported, including 13,130 in inner cities. Successful cleanup of more than 50 tons of construction waste and 3,201 of sludge waste contaminated sites with a responsible party have from municipal wastewater treatment plants.10 There been reported, including 13 large-scale sites.16 is not adequate management or infrastructure for the However, effective implementation of the Na- treatment or disposal of the special waste generated.11 tional Program for Remediation of Contaminated Although Mexico has developed some good Sites in Mexico faces several obstacles. The lack of environmental legislation and protection strate- financial resources is typically the principal reason gies for waste management,12 they are not being that remediation projects are not implemented. properly implemented, especially locally, and are Other key obstacles include: not sufficient. While many municipalities have de- veloped Municipal Programs for Integrated Preven- •• Government institutions without appro- tion and Management of Waste, many—especially priate management and technical skills. smaller ones—have not.13 Limitations in municipal legal and political frameworks result in an ineffective •• Lack of standard and consistent technical implementation of integrated waste management,14 guidelines for remediation. such as a lack of technical and management capacities as well as recurrent difficulties in the financing and •• A legal framework that is not consolidated sustainable operation of the necessary infrastructu- with respect to sustainable soil use, sustai- re. Moreover, the private sector lacks incentives. nable city planning, and the revitalization Environmental awareness is only beginning to take of inner city areas. hold among the general public and political decision makers. Municipal waste financing mechanisms have •• Lack of risk communication procedures had limited success. and guidelines related to contamination. There are reportedly more than 700 contamina- Reducing the Footprint of Growth ted sites in Mexico, and the number has been stea- •• Incomplete information system to provide dily increasing over the last few years.15 Roughly the decisionmakers with solid informa- half of the contaminated sites are under federal ju- tion for sustainable land use and site risdiction (for example, hazardous waste generators) revitalization. and half are under municipal or state jurisdiction (such as municipal landfills or dumpsites that recei- •• Lack of financial mechanisms to support ved hazardous wastes, special waste generators, and public and private sector remediation disposal facilities). Contaminated sites can result in efforts. very significant human health impacts, often associa- ted with poor or marginalized communities due to their proximity to industrial areas/sites, and also can result in significant environmental impacts. These contaminated sites in urban areas also represent a major deterrent to economic development. Mexico has established some important policy actions to help address contaminated sites. They mexico reform agenda for inclusive and sustainable growth 83 Energy efficiency The industrial sector provides interesting op- portunities to implement policies to reduce energy Enhancing energy efficiency is essential to reduce consumption. Motors represent 36 percent of na- the footprint of economic growth in urban areas. tional electricity consumption and 62 percent of in- Recent studies in Mexico confirm the extent of the dustrial sector consumption (figure 2). Any initiative energy-efficiency potential that could be tapped at promoting more efficient motor equipment will have low cost and show that the investment required in a major impact on electricity demand. The state oil all electricity efficiency interventions is significantly company PEMEX and state power company CFE less than the investment in power plants that would have vast opportunities to enhance energy efficiency. otherwise be needed.17 The case of Mexico is of The main areas of opportunity for PEMEX’s lie in special interest because it is the second largest power its production processes and the reduction of high producer in Latin America and the Caribbean and levels of gas flaring and venting. The amount of gas the largest consumer of hydrocarbons for power that is currently flared and vented is significant, generation (figure 1). approximately equal to Mexico’s total gas imports (which amounted to about a quarter of Mexico’s total gas demand in 2008). Energy efficiency oppor- FIGURE 1. Market share of total tunities in CFE are in generation, transmission, and electricity production, 2009 distribution. Caribbean 3.8% FIGURE 2. End uses of electricity Central America 3.1% in the industrial sector Chile 4.4% Brazil 35.8% Paraguay 4.5% Colombia 4.6% Illumination 8% Other 4.6% Mexico Venezuela RB 9.0% 20.8% Refrigeration 13% Argentina 9.4% Motors 62% Source: World Development Indicators database (2009). Process 17% Energy efficiency opportunities in urban areas Source: FIDE 2008 are considerable in air conditioning, lighting, and Reducing the Footprint of Growth refrigeration, as well as in transport. Average ener- gy demand could be reduced 28 percent if inefficient equipment were replaced. Replacing incandescent Energy efficiency in water pumping is critical. lamps with efficient halogen lamps may reduce elec- The use of efficient equipment for water pumping tricity consumption for lighting by 30 percent.18 In offers a potential reduction in electricity consump- 2010, 23 million homes had refrigeration equipment. tion of 15–20 percent.20 The Mexican government With the current standard for refrigerators, in some has also developed a variety of programs to replace cases, savings of up to 60 percent can be achieved, inefficient systems with efficient ones, but this has compared with equipment manufactured before not achieved great success, mainly as a result of the 1993.19 The transport sector, which accounted for high subsidy to electricity for water pumping. 45.5 percent of all energy consumed in Mexico in 2010, also has untapped opportunities for energy efficiency gains. According to the 2009–2012 Na- tional Program for the Sustainable Use of Energy, energy consumption in this sector could be reduced from 1,739 TWh to 2,736 TWh by 2030. mexico reform agenda for inclusive and sustainable growth 84 Policy options A densification strategy for Mexican cities should be accompanied by a mobility policy. Promoting more sustainable transport policies, in- Urban management cluding mass transit and non-motorized transport, can provide numerous co-benefits in addition to There is a need to strengthen urban and land use reducing global emissions (box 1), including reduc- planning. At the federal level, responsibilities for tions in traffic congestion, a decrease in commuting urban transport, land use and environmental pro- times, a decrease in accidents, and improvements in tection, disaster risk management, and housing are public health as a result of reduced air pollution. The divided among several agencies without coordination Programa de Transporte Masivo launched by the mechanisms. At the state and municipal levels, low current administration should be maintained and capacity and limited resources have restricted urban strengthened, because it has initiated a transforma- and land use planning functions to the preparation of tion in the urban transport paradigm for medium plans for specific investment projects and to the de- size and large cities. velopment of intricate land use regulations, without any comprehensive assessment of population growth, housing and basic service needs, land use and pricing trends, growth corridors, and social issues. As a re- BOX 1. Energy efficiency and sult, typically, cities do not develop a strategic vision bus rapid transit systems of the future (and plan accordingly) rather they only lay out unarticulated sector programs. An urban and Given the historical and projected urbanization land use planning system capable of: (i) coordinating pattern in Mexico, urban transport and related efforts among agencies that deal with urban develo- land-use planning issues will be a critical compo- pment issues; (ii) designing comprehensive policies nent of overall energy use by the transport sector to manage urban growth; (iii) defining guidelines for and associated emissions. A World Bank study, the efficient municipal urban and land use planning; (iv) Low-Carbon Development for Mexico (2010), determi- integrating prevention and risk reduction policies; ned that the optimization of bus systems —namely, and (v) developing strategic studies related to the through integrated Bus Rapid Transit Systems (BRT)—is future of Mexican cities, is very much needed, and considered to be the intervention with the highest could be housed in a new agency. This agency could positive net benefits from a marginal cost abatement integrate various responsibilities and teams currently perspective. scattered amongst several ministries. Mexico is not new to such systems. The Metrobus One of the functions of a land use planning Bus Rapid Transit System in Mexico City—with dedicated system would be to design a range of instruments, bus lanes, pre-board fare collection, clean technologies, including market-based ones, to promote compact efficient intermodal connections, and rapid boarding— Reducing the Footprint of Growth cities. These include transferable development rights, was conceived as a way to simultaneously reduce traffic additional transferable rights, and dual tax rates. congestion (caused by high volumes of paratransit “colec- Transferable development rights can be one of two tivosâ€? and growing private auto use) and improve transit types: the right to convert rural land to urban use, and service in a major corridor. Early results showed, along the right to build at greater densities than normally with significant improvements in mobility along the corri- allowed by zoning laws. Dual property taxes that tax dor, a number of co-benefits. An outstanding example is land differently from buildings are useful to avoid idle the first corridor of Metrobus where, without any specific land in the center of the city and to promote the supply effort undertaken to reduce carbon dioxide emissions, a of serviced urban land. Another tool is densification 10 percent reduction in GHG emissions was generated subsidies to attract people to the center. Mexico has just by reducing fuel consumption. started to foster densification through public policies In the medium and long term,as BRT corridors are and programs, such as the guidelines and sustaina- integrated to other networks such as the subway, clean bility criteria within the Esta es Tu Casa program of technologies are deployed, and corridor densifications Mexico’s National Housing Commission. Moving starts to settle, energy efficiency gains become even more forward, cities need to develop market instruments to substantial. leverage private resources into densification. mexico reform agenda for inclusive and sustainable growth 85 High-quality urban design is required to make strategies and mechanisms trickle down to the sta- high-density developments more acceptable. For tes, there is an urgent need to focus attention and existing urban areas, urban redevelopment—inclu- resources toprevention and risk reduction measures. ding redevelopment of contaminated brownfields This can be done through several mechanisms: (i) within cities—will prove essential to gauge the establishing a standard methodology for risk iden- economic benefits of urbanization and to make den- tification, assessment, and quantification to enable sification attractive for private sector investment and the federal and sub-national governments to design, labor mobility. In the future, urban planners should prioritize, and implement disaster risk reduction pro- be required to attach price tags to their urban plans grams for existing infrastructure, build resilience into to better understand the costs and benefits of low- new infrastructure, strengthen the public investment versus high-density development.21 system, and integrate design standards for priority For new developments, land-based financing sectors, such as education, health, transport, water instruments can pay for the provision of urban in- and sanitation, and low-income housing; (ii) linking frastructure. The underlying premise of land-based federal resources for reconstruction to the develop- financing of infrastructure is that the benefits of in- ment of a comprehensive disaster risk management frastructure projects are capitalized into land values. strategy at state and local level; (iii) incorporating risk As long as the special distribution of project benefits reduction policies in urban and land use planning. can be internalized within a well-defined “benefit States are ideally positioned to play a coordinating zone,â€? it is economically efficient to finance infras- role in disaster prevention and risk reduction as they tructure projects by tapping the increments in land are able to assess risk on a regional and local scale. values resulting from them. Land-based financing Building sub-national capacity and creating incenti- instruments include betterment levies, developer ves for better and informed investments at that level land sales, value capture via project-related land sales, are key contributors to Mexico’s sustainable growth. the sale of development rights, developer exactions In addition, local governments need to work on pre- and impact fees, and land asset management. Most paring and enforcing strict construction standards land-financing techniques generate revenue up- linked to federal housing programs. front, thereby reducing dependence upon debt and the fiscal risks that debt financing introduces. Mexico has started to require guidelines for Brown agenda sustainable new developments. These call for investments in green spaces, social services, public Integrated waste management strategies and so- transport, and other infrastructure to ensure that new lutions at the national, state, and municipal levels developments will be socially inclusive and linked are crucial. Overall it is necessary to reinvigorate the to employment and economic opportunities. Since implementation of the National Waste Management 2010 several housing institutions have incorporated Program. Specifically, action is required to do the Reducing the Footprint of Growth the core elements of the guidelines into their policy following: and programs as part of the country’s Sustainable Housing Program (Programa Sustentable de Vivien- of •• Install a significant number  new da). Importantly, the Instituto del Fondo Nacional sustainable municipal or regional solid de la Vivienda para los Trabajadores, which finances waste disposal facilities and special waste 70 percent of all mortgages in Mexico, is aligning management systems (collection, transport, its operational and financial plan toward this end. treatment, and disposal). But more should be done, specifically regarding the development of financial instruments to accompany  o facilita- •• Establish financial mechanisms t green urban growth. te the long-term sustainability of municipal Land use planning and reinforced building solid waste disposal systems, including both codes are effective tools to reduce natural disaster construction and operation. risks and should be part of Mexico’s comprehen- sive disaster risk management strategy. Besides  •• Resolve limitations i n municipal legal strengthening FONDEN’s operational efficiency frameworks to allow for an effective deve- and making sure that risk financing and insurance lopment and implementation of Municipal mexico reform agenda for inclusive and sustainable growth 86 Programs for Integrated Prevention and and risk assessment); improve institutional capacity Management of Waste. to investigate, reduce, and prevent contamination, and establish policy and market instruments to ad- o allow installation •• Establish conditions t dress site contamination at mining and oil and gas of waste-to-energy projects that use the operations. high organic material content in Mexican It is also important to keep in mind policy and sanitary solid waste. related actions to improve the availability, quality, and cost of Mexican-based environmental goods  nd conditions •• Create market mechanisms a and services. These will produce jobs, goods, and to significantly expand waste recycling. services to measure, prevent, minimize, correct, and manage environmental damage. Cleaner industrial •• Implement actions to enhance private technologies, wastewater treatment, solid waste dis- in solid waste and hazardous sector actions  posal, waste recycling, soil and water contamination integrated waste management, including investigation and remediation, noise and vibration waste generation reduction, so as to create control, environmental analytical and testing servi- market conditions that promote more waste ces, and environmentally preferable products should recycling companies and establish fair, open, be emphasized. and transparent conditions for promoting private sector hazardous waste disposal companies. Energy efficiency •• Take actions to increase public awareness Energy subsidies need to be revised. The price of  nd thus public demand for sound waste a energy is a crucial signal to consumers. If energy pri- management. ces are distorted, energy rationalization gets harder. In general, the government should assign greater The government should develop and implement priority to public policies aimed at poverty reduction various actions to more quickly address the full than to the use of subsidies on energy products. In range of existing issues related to contaminated this regard, it should be ensured that prices reflect sites in Mexico, associated with both the public the costs of providing goods and services or their and private sector. A National Program for the international benchmarks, as the case may be. Remediation of Contaminated Sites exists but needs Energy efficiency labeling, and standards in to be strengthened. This should include development housing, transport, and small businesses, should of appropriate alternative financial instruments and be used. While Mexico has been implementing mechanisms to provide the capital needed for site re- standards of equipment and systems, this only covers mediation, for both public and private sector–driven a portion of the domestic market. For this reason, Reducing the Footprint of Growth site remediation. These need to include a range of Mexico’s government should promote the imple- instruments, from governmental budgetary funding, mentation of a greater number of standards. For remediation, and redevelopment funds, to financial instance, Mexico could move toward the adoption mechanisms to promote cleanup at private compa- of standards similar to those in developed countries, nies’ existing operations. There is a need to establish creating new demand for already locally produced policy instruments that promote brownfield redeve- goods. Without creating barriers to trade, Mexico lopment of contaminated sites, such as revenue and could seize the opportunity to align energy efficiency incentive frameworks to compensate developers for standards for cars with those in the United States the risks involved in site remediation, building upon or Europe (where many of its cars are sold). Mexico international best practices of brownfield redevelo- could consider the whole urban environment to pment, legal and contractual conditions that resolve achieve significant energy efficiency gains, taking ownership issues and establish effective liability into account not only appliances or equipment but protection, and clear and uncomplicated processes buildings, urban infrastructure, transport, and waste for environmental licensing and land use should be management. developed. There is also a need to establish further The private sector can be more involved in regulatory guidance (for example, cleanup standards financing investments in energy efficiency. The mexico reform agenda for inclusive and sustainable growth 87 recent reform of the oil and gas industry represents room to invest in energy efficiency or perform at a positive step in promoting greater efficiency in the their potential. This gap, however, can be closed by sector and attracting investments from private com- ESCOs, which offer shared savings, the guarantee panies. The development of nationally appropriate of investments by the ensuing efficiencies, and even mitigation actions could also be pursued to encou- the potential to unlock the required initial capital rage the private sector’s participation through the investment by tapping specialized firms. development of industrywide coordinated efforts to Banks can be familiarized with energy-efficien- phase out ozone-depleting substances and increase cy lending to reduce perceived risk. Lack of access appliances’ efficiency. It is intended that any new to commercial financing has been a major impedi- mechanism will be defined no later than in 2015 and ment to expanding the market for energy-efficiency its implementation will take place no later than in retrofitting projects. Banks are not accustomed 2020. Finally it is expected that the Government of to this type of project lending. They do not accept Mexico will play an important role in the configura- receivables from performance contracts as collateral. tion of these private sector mechanisms. And they are uncomfortable with lending to project The creation of Energy Service Companies developers, such as ESCOs, which are usually poorly (ESCOs) should be promoted. ESCOs have been capitalized. A step-by-step process is needed to fa- successfully implemented in some countries. The miliarize banks with this market to reduce perceived ESCO concept is that these companies invest their risk, which can enable the adaptation of loan-evalua- own resources in energy efficiency programs, and tion criteria and possibly the design of appropriate the costs and benefits are paid from the savings; in instruments. A first step would be to get financial all cases benefits are shared from day one between and technical experts working jointly to identify and the company and the investor. ESCOs could be design financing schemes based on energy savings. particularly useful in the case of PEMEX and CFE. Both financial and technical experts must create stra- Often these state-owned enterprises are constrained tegies and schemes that show the economic benefits by federal budget ceilings that leave them little of implementing sustainable projects. Reducing the Footprint of Growth mexico reform agenda for inclusive and sustainable growth 88 Matrix of short- and medium-term policy reform options* Reform area Short-term options (1 year) Medium-term options (2–3 years) · Design market-based instruments for densification · Strengthen and broaden the DUIS initiative to and land-based financing of infrastructure. (AR&LR) achieve intersectoral coordination (AR & LR) · Promote high-quality urban design and innovation · Design and set in place an urban management Urban through government programs. (AR& LR) database at municipal and metropolitan level (AR) management · Improve coordination of territorial planning (state level) · Strengthen PROTRAM (AR) and urban development plans (municipal level). (AR&LR) · Support state and municipal level building · Improve quality and standardization of risk codes that contribute to disaster prevention identification instruments (that is, risk atlas) and (AR) promote integration with city planning. (AR&LR) · Resolve limitations in municipal legal framework to allow for an effective development and implementation of Municipal Programs for Integrated Prevention · Install a significant number of new sustainable and Management of Waste. (LR) municipal or regional solid waste disposal facilities · Establish financial mechanisms to facilitate and special waste management systems. (AR) long-term sustainable municipal solid · Establish conditions to allow installation of waste- waste disposal systems. (AR&LR) to-energy projects that use the high organic material · Establish adequate long-term budget content in Mexican sanitary solid waste. (AR&LR) for implementation of updated National · Create market mechanisms and conditions to Waste Management Program. (AR&LR) significantly expand waste recycling. (AR&LR) · Develop appropriate alternative financial · Implement actions to enhance private instruments/ mechanisms to provide the capital sector actions in solid waste and hazardous needed for site remediation, for both public and integrated waste management. (AR) private sector–driven site remediation. (AR) Brown agenda · Establish appropriate alternative financial · Establish adequate long-term budget for instruments/mechanisms to provide the capital implementation of updated National Program for needed for site remediation, for both public and the Remediation of Contaminated Sites. (AR&LR) private sector–driven site remediation. (AR&LR) · Establish regulatory guidance (such as · Establish policy instruments that promote brownfield cleanup standards, risk assessment, and redevelopment of contaminated sites. (AR) so on); improve institutional capacity in · Establish policy and market instruments regulatory compliance to investigate, reduce, to address site contamination at mining and prevent contamination. (AR&LR) and oil and gas operations. (AR & LR) Reducing the Footprint of Growth · Establish framework/types of multistakeholder · Ensure adequate resources are allocated to comprehensive sustainable environmental environmental management. (AR & LR) management planning in coastal tourism areas, including institutional and financing aspects. (AR) · Strengthen institutional capacities and enhance coordination between governmental authorities and relevant stakeholders. (AR) · Promote access to commercial financing. (AR) · Promote the creation of energy service companies. (AR) · Use labeling and standards programs · Capture energy efficiency opportunities in PEMEX for electric appliances used in residences Energy efficiency and CFE through Energy Service Companies. (AR) and small businesses. (AR) · Involve the private sector in financing · Revise energy subsidies. (AR) investments in energy efficiency. (AR) · Capture cogeneration opportunities in PEMEX. (AR) * LR= Legal Reforms; AR=Administrative Reforms, Preliminary Classification mexico reform agenda for inclusive and sustainable growth 89 Notes 1 Urban anchor, powerpoint 2012. 2 Urban population growth rates for 1970–90, 1990–2010, and 2010–30 (estimates) were 3.4 percent, 1.9 percent, and 1.2 percent, respectively. During these same periods total population increased by 2.4 percent, 1.5 percent, and 0.9 percent, respectively. 3 Average data. Sedesol, la expansion de las ciudades en México 1980, 2010, and 2012. List of metropolitan areas and cities selected. 4 UAM-Xochimilo, Estudio de impacto de las políticas de vivienda. 5 Instituto Mexicano de la Competitividad (2010). 6 SCNM. Sistema de cuentas económicas y ecológicas de México, 2003–2008. 7 Secretario de Desarrollo Social, Mayo 2010. 8 Programa Nacional para la Prevención y Gestión Integral de los Residuos 2009–2012. SEMARNAT. 9 Programa Nacional para la Prevención y Gestión Integral de los Residuos 2009–2012. SEMARNAT. 10 Diagnostico Básico para la Gestión Integral de los Residuos, SEMARNAT( 2006). 11 Programa Nacional para la Prevención y Gestión Integral de los Residuos 2009–2012. SEMARNAT. 12 For example, Ley General para la Prevención y Gestión Integral de los Residuos y su Reglamento y sus Normas Oficiales Mexicanos; Programa Nacional para la Prevención y Gestión Integral de los Residuos 2009–2012 (SEMARNAT) 13 One undocumented estimate says that approximately 200 out of nearly 2,500 municipalities may have a complete plan; Mexican GIZ Waste Management Program. 14 For example, annual budgets and a three-year mayor’s tenure do not allow for long-term sustainability planning or the capacity to access financing. 15 Communication SEMARNAT. 16 Talleres de FNM en Aguascalientes, Paseo Santa Lucia, IMMSA en Monterrey, IMMSA en San Luis Potosi, Refinería 18 de marzo, Arenque, La Venta, Azufrera Panamericana II, Pozo Dos Bocas, TAD Aguascalientes Mexico National Program for the Remediation of Contaminated Sites. Presentation by SEMARNAT at ICCL Meeting, Washington DC (2011). 17 Johnson, T., and C. Alatorre, “Low Carbon Development for Mexico.â€? Washington, DC: World Bank (2010). 18 Equipos de Aire Acondicionado y Principales Usos Finales en el Sector Doméstico de la Ciudad de Mérida, Yucatán; FIDE Review; Energía Racional No. 44 Jul.– Sep. 2002 (M. Maqueda et al.). 19 La Experiencia de México en Ahorro de Energía; Ing. Odón de Buen; Santiago de Chile; Julio de 2005. http://www.cepal. org/drni/noticias/noticias/2/22062/Odon.pdf. 20 Estudio de Mercado para Estimar la Magnitud del Potencial de Ahorro de Energía Eléctrica en Bombeo Municipal, a Nivel Nacional 2009–2030; study prepared for FIDE by Applied Technology Center de México S.A. de C.V. (L. Gámiz, January 2009. Reducing the Footprint of Growth 21 By planning higher density residential land uses, cities can shorten the length of all linear infrastructure networks (roads, streets, water lines), thus substantially reducing the capital and life-cycle costs per household. Recent estimates suggest that initial capital costs for urban infrastructure per household in high-density (272 units per hectare) developments are more than 250 percent lower than in low-density ones (22 units per hectare). mexico reform agenda for inclusive and sustainable growth 90 References CONAVI. Instituto Mexicano de la Competitividad. 2010. Johnson, T., and C. Alatorre. 2010. “Low Carbon Development for Mexico.â€? World Bank, Washington, DC. Programa Nacional para la Prevención y Gestión Integral de los Residuos 2009–2012. SEMARNAT. Secretario de Desarrollo Social, Mayo 2010. Sedesol, la expansion de las ciudades en México 19802010, 2012. List of metropolitan areas and cities selected. Talleres de FNM en Aguascalientes, Paseo Santa Lucia, IMMSA en Monterrey, IMMSA en San Luis Potosí, Refinería 18 de marzo, Arenque, La Venta, Azufrera Panamericana II, Pozo Dos Bocas, TAD Aguascalientes Mexico National Program for the Remediation of Contaminated Sites. Presentation by SEMARNAT at ICCL Meeting, Washington DC (2011). UAM-Xochimilo, Estudio de impacto de las políticas de vivienda. Reducing the Footprint of Growth mexico reform agenda for inclusive and sustainable growth 91 mexico reform agenda for inclusive and sustainable growth 93 Using Natural Resources in an Optimal Way Executive summary Message 1. In a country where forests play a very strategic environmental and social role, high forest degradation is a cause for concern. Policy options to reverse this trend include shifting funds from reforestation to community forestry and paying for environmental services; strengthening advisory and monitoring systems; fostering sustainable and competitive community enterprises; developing approaches for forests with high biodiversity values but relatively low commercial value; and promoting cross-sector coordination and public participation in policymaking. Message 2. Per capita water availability has decreased by a factor of four in the last 50 years. This situation is compounded by an inefficient use of resources in agriculture as well as in urban water services; service quality is below OECD standards. Recent projec- tions show the situation will worsen if no action is taken. The new administration should therefore give priority to establishing a set of policies and incentives to promote a more efficient allocation and usage of water resources, and improve the quality of service. Message 3. The possibility of Mexico turning into a net oil importer poses the challenges of radically transforming the country’s energy matrix compo- sition and also reducing its competitiveness. A key option to promote green growth, enhance energy security, and reduce vulnerability lies in further exploiting the use of renewable energy sources; in- volving the private sector in financing investments in renewable energy; and exploring the potential to expand solar and wind power. mexico reform agenda for inclusive and sustainable growth 94 Objectives To ensure sustainable and optimal use of its common property natural resources, Mexico will need to stren- gthen its focus on enhancing stewardship in three key sectors—forests, water, and energy resources. The key objectives include the following: •• Identifying options that would contribute to Mexico’s climate agenda and build social resilience through forest management •• Ensuring economically efficient and environmentally and socially sustainable water management to promote “greenâ€? growth in the context of water scarcity and climate uncertainty •• Assessing the impacts of declining oil and gas reserves and the role of renewable energy as an alter- native and cleaner source Key challenges Forest management While forests contribute a modest 1 percent of GDP,1 they represent an essential source of employment, in- come, and livelihood for some 12 million people.2 Almost nine thousand agrarian communities and ejidos3 own around 70 percent of the country’s forests under a legally recognized collective land ownership system––a situation unique in the world. In 2008, 57 percent of the poorest quintile of rural households obtained almost one-quarter of their income from natural resource extraction, most of which was forest-related.4 In many cases, managing forests collectively strengthens social capital within communities, enabling the pursuit of other development activities. In some instances, collective management of forests increases social cohesion and reduces conflict. Forests can play an important role in mitigating and adapting to climate change. Reducing Emissions from Deforestation and Forest Degradation (REDD+) and other forest-related activities could account for almost 20 percent of reductions in greenhouse gas emissions that Mexico could achieve by 2030. If agriculture and livestock activities are included, then the entire land use, land use change, and forest sector has a mitigation potential of 30 percent (15.3 million tonnes of carbon dioxide a year).5 Forests also play an important role in adapting to climate change. By reducing erosion, regulating hydrological cycles, and protecting watersheds, forests lessen the physical impacts of floods, droughts, and other climate-related disasters that inflict loss of life and other significant dama- ge. In addition, social capital built through collective forest management may strengthen community resilience to climate-related disasters and economic downturns. Although much remains to be done, Mexico has become a global leader in forest management. Mexico’s approach, which combines community forestry, the enhancement of environmental services such as water and biodiversity, and REDD+ is increasingly recognized as a reference worldwide for its innovativeness, scale, and results. As many as four thousand communities have participated in the demand-driven programs operated by the National Forestry Commission (CONAFOR) since 2001. An estimated 2,380 communities use forest ma- nagement, and about 50 are independently certified. Furthermore, Mexico led the initial global agreement on REDD+ at the UNFCCC Conference of Parties in Cancun in 2010, where it also presented its own REDD+ Vision focusing on cross-sector integration at the landscape level. Promising REDD+ efforts are underway in selected Early Action Areas, with a learning potential of global relevance. Continued high-profile efforts and innovative thinking for REDD+ could further strengthen Mexico’s position as a leader in global negotiations and attract green investors. mexico reform agenda for inclusive and sustainable growth 95 Allocation of resources among the various Few options exist for forests with low commer- programs is not optimal. Reforestation efforts have cial value. To harvest forest products legally, commu- obtained modest results despite receiving 38 percent nities must have management plans. However, many of Mexico’s forest investments in 2011 (US$486 forests lack sufficient valuable timber to justify the million). Of the area that was reforested nationwide, cost and complications of getting a plan approved. only half was in good or excellent condition one year In other cases the government will not approve plans later, and no systematic monitoring occurs beyond due to conflicts or tenure issues. Consequently, about the first year.6 Meanwhile only 12 percent of forest 85 percent of forests outside conservation areas lack investments went to managing natural forests.7 management plans.11 Most deforestation and degra- There seems to be room for a better balancing of the dation occurs in these forests, and informal forestry budget among the various programs based on their activities are widespread there. The federal attorney performance. for the environment estimates that almost half of Existing forest programs can be improved. the industrialized timber might come from these Although the community forestry and environmental areas. However, these forests have received limited services programs seem successful, their effectiveness attention, and existing regulations and programs are falls short of potential. For example, the Instituto Na- poorly adapted to their needs. cional de Ecologia (INE) estimates that deforestation Rural policies are still too fragmented, themati- among participants in the payment for environmen- cally and geographically. In spite of recent progress, tal services (PES) program could have been reduced remaining inconsistencies among forestry, agriculture, by 3.5 percent, rather than the observed 1 percent, if livestock, and other regional and economic develop- areas at high risk of deforestation had been targeted ment policies reduce the impact and sustainability of specifically.8 public investments in rural areas. Public subsidies for The capacity to monitor investments is lagging forest management and protection, agriculture, ran- compared with the scale of the programs. During ching, mining, and urbanization often compete with the last decade, annual public investments increased each other in the same location. The lack of inter-ins- 20-fold, to US$486 million. But CONAFOR’s abi- titutional collaboration heightens the risk that public lity to effectively monitor results on the ground––in policies and subsidy programs work at cross-purposes terms of forest cover, welfare of local communities, with each other. In addition, forest and agricultural water services, and biodiversity––has lagged behind programs usually operate at the relatively small level and needs to be strengthened. The capacity and super- of individual communities and parcels, hence missing vision of private technical service providers also needs economies of scale. A broader landscape approach in- Using Natural Resources in an Optimal Way improvement.9 The significant achievements in policy cluding forests, agriculture, pastures, and other rural performance assessments will need to be expanded to lands could foster synergies among various land uses include strategic impact assessments to better identify and among various levels of governance. potential synergies and conflicts across sectors. Public engagement in policymaking is still Other policies undermine the competitiveness limited. For almost two decades Mexico has been of community forest production. Despite the actively supporting consultation platforms such as overall success of community forestry, legal timber the Consejos Forestales, Promotorias Forestales, and production nationwide fell by 30 percent since Foros Regionales de Recursos Naturales, and most forest 2000, and the trade deficit for forest products more investments are driven and implemented by commu- than doubled.10 Other policies seem to undermine nities themselves as owners of the forests. However, public investments in the sector. These include until recently there was insufficient space for civil so- unnecessary requirements and slow approvals of ciety and community inputs into broader policyma- management plans by the Ministry of Environment king, especially in relation to REDD+. The creation (SEMARNAT), which make community efforts less of the national multi-stakeholder consultative com- competitive. Diverse circumstances that vary across mittee for REDD+ (CTC REDD+) was a key step the landscape may aggravate the problem, including in that direction. Nevertheless, greater civil society difficult access to credit; land tenure issues; and participation, especially grassroots organizations and insufficient infrastructure, public services, and mar- indigenous peoples’ groups at the local level, is needed keting assistance, as well as weak institutional efforts to promote successful climate change adaptation and to curtail illegal logging. mitigation programs in the field, including REDD+. mexico reform agenda for inclusive and sustainable growth 96 Water management In recent years, Mexico has strengthened its position in the field of climate change adaptation, taking the Mexico faces increasing stress on water resources lead in the region. Nevertheless, great challenges still resulting from population and economic growth lay ahead, in particular in implementing the propo- as well as a suboptimal management (including sed policies, especially on the demand management inefficiency, overexploitation, and pollution). side, and making efficiency improvements. The While significant regional disparities with regard provision of accurate and timely weather and climate to water availability exist,12 Mexico is dealing with information still needs to be developed. The existing increasing water stress.13 Increasing population and institutional framework does not easily allow the economic activities only partially explain the water development of the inter-institutional arrangements scarcity experienced by some areas of Mexico. Water that are often required for the development of multi- use is relatively inefficient. Irrigation techniques are sectoral projects, which are usually required for generally highly water-intensive, farmers tend not climate change adaptation. to select crops with regard for changing climate Water scarcity and climate uncertainty combi- conditions and water availability, and electricity ned with generally poor water services represent a tariffs for agriculture are highly subsidized. Many of serious threat to green growth prospects in Mexi- the water supply and sanitation utilities also do not co. World Bank projections show the situation will make efficient use of water resources,14 generating worsen if no action is taken. The importance of water significant impact, especially in predominantly urban for green growth is evident, and successive Mexican watersheds such as the Mexico Valley.15 Overexploi- administrations have declared water to be a “strategic tation of groundwater resources remains a significant matter of national security.â€? Ample evidence is avai- problem.16 lable about the economic costs associated with water Mexico already faces water stress, which is exa- problems in Mexico. In the Valley of Mexico alone, cerbated by the impact of climate change. Climate more than 30 percent of water uses are not economi- change is increasing the frequency and intensity of cally efficient, and annual economic costs resulting weather-related extreme events and changing pre- from poor urban water management (including poor cipitation patterns. There is a pressing need to water services) is estimated at US$2.4 billion annua- incorporate climate change impacts into water re- lly, or 1 percent of the Valley’s GDP (figure 1). These sources management policy and to develop planning costs are largely borne by lower income residents exercises to reverse the negative trends in the sector. dealing with high coping costs, and could grow to Using Natural Resources in an Optimal Way FIGURE 1. Sources and uses of urban water in the Mexico Valley today and in 2030 in a business-as-usual scenario 120 100 Local Aquifers 80 De cit (overexploitation) Flow (m3/s) 60 Inter-basin 40 transfers Local Aquifers 20 (sustainable) Surface water 0 unsustain. sustainable e cient ine cient unsustain. sustainable e cient ine cient Water sources Water uses Water sources Water Uses 2011 2030 Source: World Bank sta calculations mexico reform agenda for inclusive and sustainable growth 97 US$3.5 billion and 1.7 percent of GDP by 2030 if the country’s declining oilfields. The effects from no action is undertaken.17 Despite very significant the declining oil production can be felt presently, investments in the sub-sector, only about one-third as the country’s energy trade balance surplus has of large Mexican utilities provide continuous supply decreased. The sharp decrease in oil production and to their customers, with no significant improvement the country’s high dependency on hydrocarbons are over the past 10 years,18 a glaring exception in the the two main factors affecting the sustainability of OECD zone. The implicit electricity subsidy provi- the energy matrix. This has important implications ded to Mexican farmers for pumping groundwater for the way the government should handle energy has been estimated to be about US$700 million per subsidies and overall energy policy. year.19 The possibility of Mexico turning into a net oil The water sector is also challenged by incomple- importer poses the challenge of radically transfor- te reforms of its institutional and legal framework. ming the energy matrix composition and affecting In spite of the institutional innovation conveyed in its competitiveness. PEMEX’s net trade balance the reform of the legal system in 1993 and 2004, the has decreased since 2006. Most of that decrease is implementation of key legal and administrative ins- explained by the growing tendency of hydrocarbon truments has not fully or efficiently taken place. For imports to fill the gap between domestic supply and instance, the water rights, originally conceded based demand. If this tendency continues in the years to on self-declarations, should have been renovated come and domestic hydrocarbons supply does not every 20 years based on field surveys of actual use and offset it, PEMEX’s trade balance may turn negative water availability, but in most cases they have been ex- (figure 2). Such a scenario would profoundly affect tended automatically. The decentralization initiated the energy sector and the fiscal balance. in the nineties, transferring service provision respon- sibilities to municipalities, was not accompanied by the expected improvement in financial sustainability FIGURE 2. PEMEX trade balance or service quality. In fact no mechanisms were put Trade Balance of PEMEX in place to ensure that service quality, sustainability, ($US Billion) and affordability were regulated in a consistent and 30 nonpolitical manner. Despite very significant federal investments in the sector, the Sistema Financiero del 25 Agua proposed in the 2004 Water Law has not been implemented; most operators and water users asso- Using Natural Resources in an Optimal Way 20 ciations continue to depend on unpredictable and $US Billion sometimes arbitrary federal investment programs 15 (50 percent of total investment in the sector) that, 10 overall, tend to undermine the ownership, efficiency, and sustainability of local entities. 5 0 Energy diversification 2006 2007 2008 2009 2010 2011 Source: PEMEX The heavily based hydrocarbon structure deter- mines the configuration of the power sector. For instance, 73 percent of Mexico’s installed power generation capacity is fossil fuel–based. Through the Energy sector challenges have broader policy im- introduction of newer technologies and regulatory plications. High oil dependence, an undiversified changes, the power sector has become the main energy matrix, reduced investment in oil and gas driver of natural gas demand in Mexico. exploration and production, declining oil production, Oil supplies are declining, and this affects and reduction in the hydrocarbons trade surplus are the future performance of the energy sector. The interdependent and have important implications for outlook for Mexico’s supply-and-demand energy fiscal balance, public investment policy, and debt ma- structure in the near to medium term is molded by nagement. Any significant changes in the pricing or mexico reform agenda for inclusive and sustainable growth 98 availability of primary fuels, whether in power pro- Renewable energy provided only 14 percent duction, transport, or other energy-intensive sectors, of Mexico’s electricity generation in 2009 despite will affect consumers throughout the economy. important endowments in wind, geothermal, and Oil revenues are projected to fall as reserves solar energy. Since 1990 there has been a decline and production decline in the years to come. Oil in the share of renewable energy sources (table 1). revenues contribute at least one-third of the federal This is primarily due to the declining relative share budget and are a major source of funds for general of hydro; the total share of non-hydro renewable social spending. The burden of fiscal adjustment to sources increased slightly. Over the past two decades oil price swings and other external shocks has there- the main shift in energy generation has been from fore fallen on public expenditures. Given that current oil-fired plants to natural gas and, to a lesser extent, expenditures are difficult to reduce in the short term, coal. the primary fiscal response to external shocks has For the period 2009–2012, the goal of the Pro- been to make drastic cuts in capital expenditures. grama Especial para el Aprovechamiento de Energías Because PEMEX and CFE investments comprise Renovables has been to increase renewable capacity a large share of the capital budget, the investment (excluding hydro capacity larger than 30 MW) by budgets of these enterprises have borne an important up to 7.6 percent and its share in total energy gene- share of such unanticipated cuts. ration to 4.5–6.6 percent. Almost all of the planned Mexico’s energy sector has found itself in a increase to 2012 would be from wind energy. In vicious circle, in which reduced budget and bo- addition, the program has the goal of making elec- rrowing capacity has restricted sector investment, tricity available to 2,500 rural communities by using in turn limiting the expansion of production and renewable sources. government revenues. This has made it more diffi- More broadly, and over the longer term, the cult to fund future financial needs. The government National Energy Strategy has the goal of achieving is increasingly forced to choose between the call to a 35 percent share of generation capacity- through spend on urgent social programs now, and the need renewable energy (including large hydro), nuclear to invest in energy now to maximize value creation energy, and “clean fossil fuelâ€? technologies by from oil production, meet the growing demand 2024.20 Overall, the share of renewables in terms of for energy, and accumulate funds for future public output is expected to remain almost unchanged by spending. the end of the period—14 percent of the projected Using Natural Resources in an Optimal Way TABLE 1. Evolution of share of energy sources in electricity output in Mexico, 1973–2009 (percent unless otherwise noted) Energy source  1973 1980 1990 2000a 2009 Total (including self-generators), (TWh) 37.1 67.0 115.8 204.2 261.0 Oil-fired 41.1 57.9 53.6 46.2 17.5 Natural gas–fired 14.2 15.5 12.5 20.3 53.1 Coal-fired 0.6 0.0 6.7 9.5 11.3 Nuclear 0.0 0.0 2.5 4.0 4.0 Hydro 43.6 25.2 20.3 16.2 10.2 Non-hydro renewable 0.4 1.4 4.4 3.7 3.9 Biomass 0.0 0.1 0.0 0.8 1.0 Geothermal 0.4 1.3 4.4 2.9 2.6 Wind and solar 0.0 0.0 0.0 0.0 0.2 Note a. 2009 was a relatively dry year, which diminished hydro output by ~15 percent from the mean, equivalent to a reduction of about 2 percent in the share of total generation. The other years shown had river flows within the “typicalâ€? range (CFE, 2011). Source: International Energy Agency, http://www.iea.org, Energy Statistics of OECD Countries. mexico reform agenda for inclusive and sustainable growth 99 total of 415 TWh for public service. In the next reserves of shale gas are more than three hundred sections the projected expansion is reviewed in light times what was consumed in 2010. Worldwide of the potentials of the different renewable energy development of shale gas, especially in the United resources. States, will be important to revolutionize technology, Recently there has been increased emphasis on incentivize production in Mexico, and help to lower the development of small and micro hydro, which the market price of gas, making it a competitive is seen as having lower environmental impacts alternative source against other fuels and energy sou- than larger hydro projects. It is estimated that rces. Some challenges lay in the future development there are roughly 3.3 GW of remaining small hydro of gas. The investments required to develop shale gas potential. The inventory of small hydro potential is reserves in Mexico are huge and the adoption of new quite sketchy outside of a few states. But even a rapid technologies may be difficult at the beginning. In development of most small hydro potential would addition, several environmental concerns will have to not have a large impact on the generation mix. For be settled in an appropriate manner and an underde- example, tripling the planned expansion of small veloped internal gas transportation system will need hydro from 375 MW to 1,125 MW would increase to be upgraded. output by about 2 TWh, or 0.5% of total generation in 2025. Development of wind generation has steadily grown but wind generating capacity in 2009 was Policy options still only 85 MW. However, it is increasing rapidly and is projected to exceed 3,000 MW in 2014 and 5,500 MW by 2025 (SENER 2010). Assuming a Forest management capacity factor of 33 percent (average of the capacity existing in 2009), this would be equivalent to 16 Rethinking the balance and packaging among TWh, less than 1 percent of total generation. programs would seem relevant at this time. In Since 1973, Mexico has been one of the world’s particular, it would be useful to provide communities pioneers in exploiting geothermal energy for elec- with more integrated support, combining multiple tricity generation. Capacity has grown fairly slowly programs and seeking optimal policy mixes at the lo- over the years and was 965 MW in 2009 (1.9 percent cal level. Shifting funds from plain reforestation to a of total installed capacity). Geothermal plants are combination of community management of standing base load with high capacity factors, which have ran- forests, restoration of degraded lands, and payment Using Natural Resources in an Optimal Way ged between 78 percent and 88 percent since 1999. for environmental services would be a logical step Output in 2009 was 6.7 TWh, or about 2.9 percent considering the positive social, economic, and envi- of total generation. ronmental outcomes these programs have generated Mexico is one of the best-endowed countries in so far. Reforestation efforts can be improved, but Latin America for solar energy, but this advantage this will require major changes in approach and will has not translated into commensurate electricity take time. There are often cheaper alternatives for generation because of the high cost of the associa- promoting forest regrowth than reforestation, and ted technologies. Their use has been restricted to where economically justified, reforestation efforts mostly small isolated rural systems. But the cost of could be more integrated, selective, and geographica- photovoltaic systems fell dramatically from 2009 to lly focused. In addition to rebalancing funds among 2011. While far from competing with alternatives for programs, it is important to provide flexibility for central station supply to the grid, this cost reduction communities to mix programs in ways that better has put PV systems close to economic viability for recognize the complexity of rural landscapes. distributed generation among segments of consumers Strengthening CONAFOR’s advisory and paying higher prices for electricity. Mexico is also monitoring systems is essential for the success of developing the first concentrated solar power (CSP) forest programs in the field. Priority could be given plant in Latin America in Agua Prieta, Sonora. to the staffing and training of regional offices, and The potential of Mexico’s shale gas development to the development of cutting-edge remote sensing is vast, yet many challenges must be overcome to and geographical information systems. The training realize it. According to the EIA estimate, potential and accreditation of private experts who advise mexico reform agenda for inclusive and sustainable growth 100 communities is also critical. This effort will be all the Promoting cross-sector coordination and a more important because monitoring, reporting, and landscape approach would enhance comprehensi- verification (MRV) will be a key element for a future veness. CONAFOR and the Ministry of Agricultu- REDD+ system. re (SAGARPA) are developing joint databases and Fostering the ability of community enterprises making efforts to align policies, ensure consistency to compete with other suppliers would greatly among subsidy programs, and develop new incentives contribute to environmental sustainability and for climate-smart management of land and forests at socioeconomic development. Simplifying the the landscape level. A series of inter-municipal co- requirements for community management plans llaborations are also emerging, following the model and reducing the time required to approve them, of the Junta Municipal del Río Ayuquila ( JIRA), with particularly for forests with low timber volumes and the aim of improving integration of public policies for non-timber products, could allow large additional at the territorial landscape level, fully engaging local areas to be legally managed for production. New actors, and leveraging additional resources. Pursuing mechanisms that recognize long-standing informal these nascent efforts and promoting the scaling up of forestry activities could enable them to get help to successful pilots will be essential to using forests as become more sustainable. Communities with forests a platform for sustainable development and a buffer certified by recognized third-party auditors could against climate change impacts in rural areas. be exempted from many regulatory requirements. Fostering public participation in policyma- Efforts should be made to resolve unclear tenure king can bring positive effects. Efforts are already situations and allow communities to manage forests underway to foster greater public participation in legally, especially where no opposing claims to those policymaking, especially in the innovative REDD+ forests are present. New loan guarantees and collate- area. These include the creation of local consulta- ral instruments could facilitate communities’ access tive committees for REDD+, direct engagement to private credit for forestry activities. Given limited with grassroots organizations in designing and resources, forest law enforcement efforts would be implementing pilot programs, a new collaboration more effective if they were concentrated on critical with the Comisión Nacional para el Desarollo de los areas. Mexico’s Congress approved a bill for climate Pueblos Indígenas (CDI) and the Instituto Nacional change that mandates the use of economic, market, de las Mujeres (INMUJERES), the development of fiscal, and financial instruments to promote the a consultation protocol for REDD+ jointly with civil principle that those who conserve also shall receive society organizations, and a comprehensive commu- the benefits. Since many communities actually bear nication strategy. Moving forward, it will be essential Using Natural Resources in an Optimal Way the cost of public services and infrastructure, fiscal to intensify and expand these partnerships. incentives should be considered to recognize their contributions to the population and the environment. Developing approaches for forests with lower Water management commercial value is an integral part of the solu- tion. A combination of reducing regulatory burdens, Implementing an effective Water Financing Sys- providing small payments for managing forests with tem will set the incentives for a more optimal use low timber volumes and for protecting forests from of water resources. The 2004 Water Law states that fires and grazing, and improving technical support the creation of a Water Financing System is critical services, could make it possible to greatly improve to supporting the integrated and sustainable mana- forests’ condition and livelihoods in forest areas gement of the nation’s water resources. The Water outside the main timber production regions. This Financing System should determine the financial approach, facilitated by greater integration between needs of the sector; identify current revenue levels the different forest programs, could increase carbon and all sources of funding being channeled to the stock in approximately 20 million forest hectares sector (ODA, federal, state and local transfers, the nationally. For example, payments for environmental private sector, tariffs, and other financing instru- services could be expanded from strict protection ments); define key principles governing sector finan- and used to complement sustainable management in cing; identify potential sources of revenue generation less profitable areas, or in high-biodiversity areas at for the sector; monitor and evaluate the impact of risk of degradation. financing; propose measures to increase and diversify mexico reform agenda for inclusive and sustainable growth 101 the funding base; and improve the optimal use of rather than government fees push up the perceived financial resources. Additionally, federal investment marginal value and allowing water users to capture programs should be reformed to link the decisions the capital value of their water allocation through of resource allocation with actual performance in the establishment of tradable water rights in critical improving efficiency and quality of service, ensure watersheds. that activities financed are consistent with the ove- Improving the efficiency of water services in rall SFA and do not generate perverse incentives, the agriculture sector will have large payoffs. Agri- and improve the predictability and transparency of culture is the primary user of water, as it accounts resource allocation. Finally, requirements to account for about 80 percent of total water withdrawals. The for climate variability in future investments should efficiency of agricultural water services is therefore be embedded in all federal programs. instrumental to achieve an optimal use of water Consolidating the information base for cli- resources. The new administration should consider mate, water management, and water services will modifying the electricity tariff subsidy policies, ge- improve policy and decisionmaking. Critical steps neralizing volumetric water pricing, and continuing have been taken to ensure the modernization of the the modernization of irrigation techniques. Capacity Servicio Meteorológico Nacional; however, the task is building among producers will be needed to move to far from complete, and there is a need to continue irrigation of higher value crops in water-scarce areas. strengthening the information base ranging from Bringing efficiency and quality of urban water climate predictions to water management, water services up to regional OECD standards is neces- rights allocation, aquifer behaviors, and the quality sary to sustain green growth in dense urban areas. and efficiency of water services. For this to happen, a However, dramatic improvements are difficult to culture of openness, accountability, and transparency achieve in the absence of a change of approach in should be promoted throughout the sector, starting the promotion of service quality and efficiency. The with CONAGUA making its sector data available new administration should consider establishing more easily and systematically. Efforts should also be and enforcing a comprehensive policy addressing made to extend climate data as well as aquifer moni- the shortcomings of the urban water sector, in close toring. Groundwater extractions should be measured coordination with states and municipalities. This whenever possible, and water balances should be policy should focus on establishing effective service made on real extractions, not unmonitored extraction quality and economic regulation; developing more rights. The quality of service provided by water utili- sustainable and self-financed utilities; improving ties, as well as the efficiency with which they provide technical capacity of their staff; reforming the exis- Using Natural Resources in an Optimal Way that service, should be reported and made publicly ting sub-sector financing approach; and promoting available for benchmarking purposes. long-term planning in the face of climate change Improving and strengthening enforcement of and other constraints. The recent Public Policy water rights will help to cope with competing uses drafted by CONAGUA should serve as a guiding and climate variability. The water rights registry policy.21 The recent adoption of a constitutional right in Mexico covers 95 percent of all water users and to access affordable water in sufficient quantity and represents an impressive accomplishment. But the quality, together with the mandate to pass a new Wa- amount of water rights greatly exceeds sustainable ter Law within a year, offers an opening to address levels in water-scarce areas, the errors in the records the challenges mentioned at the legal level, creating remain relatively high, and effective enforcement ne- effective regulatory and accountability mechanisms eds to be substantially strengthened. Climate change for the sector. further threatens current allocations. Making the system work fully will require cleaning up records, implementing a complete administrative system to Energy diversification measure and control water usage, and setting up transparent enforcement mechanisms. The system of Energy diversification is essential to use natural water rights should be used to address the issue of resources in an optimal way. The possibility of water over-allocation and the need for an optimal use Mexico turning into a net oil importer calls for of water resources in the most water-scarce areas—in radically transforming the energy matrix composi- particular, in extreme events—by letting the market tion as well as the energy subsidies policy. Mexico mexico reform agenda for inclusive and sustainable growth 102 should focus subsidies on the poorest consumers, renewables in the country’s electricity output in 2025 while using some of the freed-up resources to boost would increase to 17 percent. renewable energy. Such measures are key to avoid a The private sector has considerable room to difficult financial situation if the government decides finance investments in renewable energy. The re- to keep its current subsidies policy without having cent law to promote renewable energy represents a compensation through fiscal reform. positive step attracting investments from the private As for renewables, their projected share in sector. This law (as well as the Power for Public Ser- Mexico’s electricity supply is expected to be about vice Law) now considers externalities but needs to the same in 2025 as in 2009—roughly 14 percent. In be strengthened. The Independent Power Producer the short term (2009–2014), the share of renewables model could be improved and extended to promote in new output is higher, roughly 21 percent, but then investments in renewable energy generation. Banks it falls. The existing plan is more ambitious in the could also have a role in promoting renewable short term than in the long term. This is much pre- energy in Mexico. Households could create a strong ferable to the inverse: little action in the short term, market for solar technologies, which (depending with ambitious long-term targets. The short-term on the region) could be integrated into mortgages actions can bring experience and conditions to build and other long-term financing mechanisms. In on. If the share of new output added by renewables partnership with the private sector, Mexico could in 2009–2014 were maintained over the subsequent also pursue the creation of Nationally Appropriate decade, the additional output required after 2014 Mitigation Actions (NAMAs) in the renewable would be about 13 TWh. In that case, the share of energy sector. Matrix of short- and medium-term policy reform options* Reform area Short-term options (1 year) Medium-term options (2–3 years) · Provide more integrated support to · Strengthen advisory and monitoring systems. (AR) communities by combining programs at · Develop approaches for forests with local level, and balancing reforestation and lower commercial value. (AR&LR) community forestry, restoration, and payment · Promote cross-sector coordination and Forest management for environmental services funds. (AR) landscape approach, especially with agriculture Using Natural Resources in an Optimal Way · Start addressing bottlenecks and livestock land uses. (AR&LR) and foster competitiveness of · Promote greater public participation in community enterprises. (AR&LR) policymaking with explicit focus on REDD+. (AR) · Develop and implement the Water Financing · Conduct a review of all federal System to promote a vision of sustainable programs to improve their targeting, and efficient sector financing. (AR& LR) alignment, and predictability. (AR) · Implement the new law and related urban water · Prepare a new water law to address service quality and efficiency policy. (AR) key challenges signaled in the policy · Continue improving the information basis on Water management note, in particular with regard to water sector data, and require nonfederal actors to rights management and water and report on their performance and service quality sanitation service provision. (LR) as a condition for federal transfers. (AR) · Consider replacing the electricity subsidy for · Improve and strengthen the enforcement of the agriculture with targeted subsidies. (AR& LR) system of water rights to cope with competing uses, in particular in the most critical basins. (AR&LR) · Continue promoting renewable energy. (AR) · Involve the private sector in financing Renewable energy investments in renewable energy. (AR) · Explore potential to expand solar and wind power. (AR) * LR= Legal Reforms; AR=Administrative Reforms, Preliminary Classification mexico reform agenda for inclusive and sustainable growth 103 Notes 1 Centro de Estudios de Competitividad 2010. 2 CONAFOR 2010. 3 Communities and ejidos are landholdings with either indigenous or non-indigenous members with rights, stipulated by law, to communal resources under which an individual family has a right to an individual plot of land allocated formally by the community as well as access to communally owned lands (often forest lands, pastures, and waterways). 4 Lopez Feldman 2011. 5 Johnson and others 2009. 6 Universidad Autónoma de Chapingo 2010. 7 Consejo Civil Mexicano de Silvicultura Sostenible 2010. 8 Muñoz Piña 2011. 9 Universidad Autónoma de Chapingo 2009. 10 CONAFOR 2008. 11 About 7 million of Mexico’s 65 million hectares of forest have management plans, 8 million hectares are in national protected areas, and 2 million hectares are in Payment for Environmental Service schemes (Merino. 2011). 12 The semiarid and arid northern and central regions account for 79 percent of GDP and contain 77 percent of total population, but they receive only 31 percent of the total runoff (CONAGUA 2011a). 13 In 1955, water availability in Mexico was 11,500 m3 per person per year. By 2005 this amount had decreased to 4,288 m3 (CONAGUA 2010). 14 The weighted average rate of Non-Revenue Water for a selection of water utilities in communities with a population of more than 50,000 inhabitants is estimated at 40 percent according to the CONAGUA (2011c); another source reports it at 49 percent, considering all larger utilities of the country (Consejo Consultivo del Agua 2011). 15 In 2009 the availability of renewable water in the Mexico Valley was only 164 m3/hab/year, well below international standards for acute water scarcity established at 1000 m3/cap/year (CONAGUA 2011b). 16 Of the 256 aquifers that supply more than 90 percent of total groundwater demands, 102 are currently considered overexploited. 17 World Bank 2012 (forthcoming). Using Natural Resources in an Optimal Way 18 Extrapolated from Consejo Consultivo del Agua 2011. 19 Guevara-Sangines 2006. 20 SENER 2010. 21 World Bank and CONAGUA 2012 (forthcoming). mexico reform agenda for inclusive and sustainable growth 104 References Centro de Estudios de Competitividad. 2010. “El sector forestal en Mexico: diagnostic, prospective y estrategia.â€? CONAFOR (National Forest Commision). 2008. “Producción y productividad forestal maderable.â€? Internal document. ———. 2010. “Mexico’s draft Readiness Preparation Plan (R-PP).â€? Submitted to the World Bank Forest Carbon Partnership Facility. CONAGUA. 2010. Estadísticas del Agua en México. ———. 2011a. Atlas del Agua en Mexico. ———. 2011b. Estadísticas del Agua en México. ———. 2011c. Situación del Subsector Agua Potable, Alcantarillado y Saneamiento. Consejo Civil Mexicano de Silvicultura Sostenible. 2010. “Analisis del proyecto de presupuesto para CONAFOR en 2011.â€? CCMSS Nota informativa 29. Consejo Consultivo del Agua. 2011. Gestion del Agua en las Ciudades de Mexico. Guevara-Sangines, A. 2006. “Water Subsidies and Aquifer Depletion in Mexico’s Arid Regions.â€? Occasional Paper No. 23. Human Development Report. United Nations. New York. Johnson, T.M., C. Alatorre, Z. Romo, and F. Liu. 2009. Low Carbon Development for Mexico. Washington D.C: World Bank. Lopez Feldman, A. 2011. “Environmental Dependence of Mexican Rural Households: Exploring the Role of Income, Shocks, Rules, and Roads.â€? Manuscript. Merino, L., ed. 2011. Encuentros y desencuentros. Las comunidades forestales y las políticas públicas en tiempos de transi- ción, p. 134 (ANP statistic). Muñoz Piña, C. 2011. “Programa de Pago por Servicios Ambientales HidroloÌ?gicos de los Bosques.â€? Presented at the Interna- tional PES Congress, Ixtapan de la Sal, Estado de México, México, August 3–5. SEMARNAT. Programa Especial de Cambio Climático 2009-2012 – DOF 28/08/2009. www.cambioclimatico.gob.mx/images/ stories/PDF/peccanexos.pdf. SENER. 2010. Prospectiva del Sector Electrico: 2010–2025. Direccion General de Planeación Energética, Secretaría de Energía. Universidad Autónoma de Chapingo. 2009. “Evaluación de la Operación de los Programas de Desarrollo Forestal, Informe Final.â€? Universidad Autónoma de Chapingo. 2010. “Informe de evaluación externa de los apoyos de reforestación, Ejercicio fiscal 2009.â€? Texcoco. p. xiii. Using Natural Resources in an Optimal Way World Bank. 2012 (forthcoming). “Urban Water Management in the Mexico Valley.â€? World Bank and CONAGUA. 2012 (forthcoming). “Política Pública para la Eficiencia Sostenible de los Organismos Operado- res.â€? mexico reform agenda for inclusive and sustainable growth 105 mexico reform agenda for inclusive and sustainable growth 107 Managing Medium-Term Fiscal Challenges Executive Summary Message 1. Mexico needs a comprehensive fiscal reform to alleviate the looming medium-term pres- sures on its budget. The country’s fiscal accounts rely heavily on oil revenue (about a third of total public revenue). But falling oil revenue and an expected increase in spending (aging-related spending, public investment, and social spending to reduce poverty and inequality) will put pressure on its public fi- nances. This calls for a greater tax revenue collection effort, increased efficiency and improved targeting of public spending, and more accurate measurement of medium-term spending and revenue trends. Message 2. Mexico’s fiscal agenda needs a revenue- enhancing tax reform. The country’s tax collection effort is low by international standards (nonoil tax revenue amounts to about 10 percent of GDP). Adopting an integral fiscal-reform strategy that broadens the tax base, simplifies the tax system by eliminating tax loopholes, and reduces tax expendi- tures could bolster revenue substantially. Message 3. Mexico needs energy pricing reform and budget stabilization measures as part of its fiscal reform. Energy subsidies are estimated at nearly 2 percent of GDP. Removing these subsidies could help the country raise revenues, avoid distorted pri- ce signals, and reach its climate change mitigation goals. Institutionalizing the oil-price hedge, lifting the stabilization fund caps, and adopting a structural balance rule could all strengthen budget stability. Message 4. Mexico’s fiscal reform agenda should in- clude a careful evaluation of the distributive impacts of the full range of proposed measures. The loss in household purchasing power resulting from increa- sed tax collection and the removal of energy subsidies must be evaluated in parallel with an increase in public spending capacity for more targeted programs. mexico reform agenda for inclusive and sustainable growth 108 Objective This policy note contributes to the debate on Mexico’s looming fiscal challenges. The country’s fiscal fra- mework, centered on the 2006 Budget and Fiscal Responsibility Law, and prudent fiscal risk management has helped maintain short-term budget stability and a fairly stable public debt path, even in times of economic volatility. However, Mexico faces serious longer term fiscal challenges that are not always recognized, measured, and addressed in policy debates, which tend to focus on approving the annual budget. And though Mexico has adopted several policies to mitigate oil-price volatility on the budget, oil production has fallen substantially over the past few years, drawing renewed attention to the longer term challenge of replacing part of the oil-related public revenue base with other, more permanent sources of revenue. Further, spending pressures associated with increasing aging-related spending, public investment, and social spending needs call for a discussion of the fiscal implications of additional impending outlays. Key challenges Mexico’s falling oil revenue and rising public spending needs over the medium term require increased tax revenue and more efficient and better targeted public spending. Even if greater economic growth and lower real interest rates provide some space for deficit financing without endangering the sustainability of public debt, the onus on fiscal adjustment is likely to rest on raising the country’s public revenue collection effort. An integral revenue-enhancing fiscal reform that broadens the tax base, reduces the scope of special regimes and preferential rates, and generates information flows on economic transactions that facilitate tax compliance and administra- tion could boost tax revenue substantially. Reducing public subsidies, especially prevalent for energy, would also increase public revenue. Mexico’s public finance depends heavily on oil revenue, with recent high oil prices masking a decline in oil production. In 2011, public revenue reached more than 3 trillion pesos (21.7 percent of GDP),1 a third of it oil-related. Crude oil production and exports have declined steadily following a peak in 2004. The government estimates that production will stabilize at 2.5 million barrels a day over 2011–15, but after years of decline, these estimates are highly uncertain. Even if production were to stabilize, a growing economy would cause oil revenue to fall as a percentage of GDP. In addition, a greater share of oil revenue is being cycled back to PEMEX and thus is not reaching government coffers, due to greater needs in oil investment and higher extraction costs. If current macroeconomic parameters, including average annual economic growth of 3.3 percent, remain constant—and the real price of oil remains stable—oil revenues would fall by 2.5 percent of GDP over 2011–30.2 And if oil prices remain constant in nominal terms, revenues would fall by 4 percent of GDP over the same period. Mexico’s long-term spending pressures are related to its demographics. The country’s increasing life expec- tancy and declining birth rates have led to an unprecedented demographic shift toward a rapidly aging popu- lation. Since 1990, life expectancy has risen 8.3 percent for men and 6.0 percent for women, and the increase is projected to continue. At the same time, Mexico’s fertility has declined steadily, from an average of seven children per woman in 1960 to just more than two today. And the population older than age 65, 6.2 percent in 2010, is projected to double to an estimated 12.5 percent by 2030. The aging population is adding to public spending on health, long-term care, and pensions. mexico reform agenda for inclusive and sustainable growth 109 Increasing health costs associated with the aging federal spending and revenues over the coming de- population, and an epidemiologic transition, will cades under multiple scenarios would help identify gradually put pressure on government spending. and evaluate upcoming budget pressures earlier than Mexico spends nearly 6 percent of GDP on health, before—and promote the proposal of mitigation approximately 2.7 percent of it public spending. measures and analysis of their budgetary impacts. Public and private health spending will gradually trend toward the OECD average of 8.9 percent of GDP, in parallel with Mexico’s demographic and epidemiologic transition. Public health spending will Policy options likely outpace private health spending, due to the low base and expansion of Seguro Popular, a noncontri- butory public health subsystem that provides health Adopting a revenue-enhancing tax reform insurance for people without social security.3 Transition costs from pension reform are higher Mexico’s tax collection effort is low by internatio- than estimated. Though the switch to a defined- nal standards. And though its federal tax collection contribution pension system for most formal-sector (13.8 percent)7 is well below the OECD average workers improved long-term fiscal sustainability, (19.2 percent), it is above that of Canada, Spain, public spending has risen, as worker contributions and the United States. When local taxes and social no longer fund defined-benefit pensions granted to security contributions are included, however, Mexico the current and transition generation of retirees. Go- drops to last place among its OECD peers (figure vernment transfers to finance existing contributory 1). And while Mexico’s social security contributions pension programs doubled from 1.2 percent of GDP amount to 2.9 percent of GDP and local government in 1999 to 2.4 percent of GDP in 2010. Transfers tax collection to 0.6 percent of GDP, those averages to the Mexican Social Security Institute (Instituto for the OECD are 8.6 percent and 6 percent, res- Mexicano del Seguro Social, or IMSS) reached 1.2 per- pectively. The property tax is an important revenue cent of GDP in 2009–10, far earlier than estimated. generator for local governments in other countries High labor informality and the associated low but in Mexico amounts to just 0.2 percent of GDP. contributory pension coverage generate signifi- The general features and statutory rates of cant contingent liabilities. Many Mexicans lack Mexico’s tax system compare favorably with those pension benefits because they are employed infor- of other OECD countries.8 But a large informal mally or because they shift between formal and in- economy and a complex tax system with loopholes Managing Medium-Term Fiscal Challenges formal employment and are thus unable to meet the and exemptions lower the tax revenues collected and minimum contributory pension requirements. Low the productivity of most tax categories.9 In addition, contributory pension coverage has released the pent preferential corporate and individual tax regimes, up demand for noncontributory pensions, reflected value added tax (VAT) exceptions, and multiple in the recent expansion of the program 70-plus (70 rates limit collection, facilitate noncompliance, and y Más) to urban areas.4 Providing a basic pension in further complicate the tax system. These exemptions, 2012 for everyone age 70 and older without an IMSS deductions, and credits (known as tax expenditures) or Institute for Social Security and Services for State generate substantial revenue losses, have the same Workers (Instituto de Seguridad y Servicios de los Tra- effect on the budget as government spending (like bajadores del Estado, or ISSSTE) pension would cost subsidies), and alter the tax system’s horizontal and the government approximately 0.2 percent of GDP.5 vertical equity. Looking more closely at these medium- and Adopting an integral reform that simplifies the long-term revenue and spending trends and publis- tax system and broadens the tax base could boost hing a medium-term budget outlook would allow revenue substantially. Recent reforms, including for long-term budget planning. The government a higher VAT, the introduction of an alternative produces a National Development Plan (or Plan minimum tax on business income, a tax on cash Nacional de Desarrollo) every six years and includes deposits, and a temporary increase in the corporate a section on fiscal risks in its annual budget presen- tax rate and marginal personal income tax10 have not tation,6 but a more dynamic, strategic, and effective boosted tax revenues sufficiently (figure 2). A more medium-term budget plan is needed. Projecting comprehensive reform strategy is needed to close the mexico reform agenda for inclusive and sustainable growth 110 FIGURE 1. International comparison FIGURE 2. Evolution of tax revenues (% of GDP) of public revenues 60 11 10.0 10.0 10 9.4 50 9.0 9.0 9.0 9.3 9 8.5 8.6 8.4 8.6 8.0 7.7 8.0 8.1 40 OECD average 34.8% 8 7.5 % of GDP 7.1 7.0 3.7 3.9 3.8 7 3.4 % of GDP 30 3.6 3.2 3.4 3.7 6 3.1 3.4 3.3 2.2 2.8 3.0 2.2 2.7 5 2.6 20 17.3 2.4 2.4 2.9 0.6 4 10 3 5.3 5.1 5.2 5.0 4.7 4.7 4.5 4.5 13.8 4.3 4.3 4.1 4.2 4.2 4.0 2 4.0 3.8 3.6 0 3.4 3.3 1 Norway Sweden Denmark Austria Italy Belgium Finland Hungary Luxemb. Slovenia Germany Iceland France Czech Rep. UK Canada N. Zealand Israel Spain Switzerland Greece Slovak Republic Ireland Korea Turkey USA Chile Mexico 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Social security cont. Local taxes Federal taxes Others Imports Excise tax VAT Income Source: OECD 2011 Source: SHCP and INEGI projected fiscal gap and guarantee that public servi- Adopting energy pricing reform and ces are provided in a sustainable manner. Spending budget stabilization measures on social security and social services, so critical for developing human capital and unlocking growth, is Mexico’s energy subsidies are high and have in- constrained by limited revenues. creased substantially over the last few years. Do- Reducing or withdrawing tax expenditures mestic energy prices, set by the Ministry of Finance would broaden the tax base and increase revenues. and Public Credit (Secretaría de Hacienda y Crédito Foregone tax revenues due to tax expenditures are Público, or SHCP), are considered subsidized if their substantial. Tax expenditures not only lower revenues price is below a reference price representing the but also ease noncompliance through tax evasion. opportunity cost (for tradable goods, such as fuel) or Withdrawing these expenditures would raise re- representing the cost of production (for non-tradable Managing Medium-Term Fiscal Challenges venue, simplify the tax system, reduce tax evasion, goods or services, such as electricity). There is no and provide useful information for tax authorities. explicit budget appropriation; rather, subsidies show Revenue foregone due to differential tax rates, tax up as lower revenue to the federal government or its exemptions, and subsidies are estimated at nearly state-owned companies. 5.1 percent of GDP for 2011. There is a growing The energy subsidies also mask resource costs, international consensus that differential VAT rates are inefficient in alleviating poverty, and are highly on goods and services may be a poor way of achie- regressive. Subsidies for electricity, gasoline, diesel, ving income distribution objectives. Transition to a and liquefied petroleum were more than 1.5 percent broad-based single-rate VAT system, the best policy of GDP on average each year over 2005–09, accor- option, would minimize compliance costs and thus ding to government estimates. Electricity subsidies increase efficiency and revenues. But if over the short in Mexico—though harder to quantify because the term removing VAT exemptions and zero rating is reference cost of production is based on an admi- not politically viable, an exemption or lower rate nistratively set rate of return of capital and also may could initially be retained on a small basket of staple include inefficiencies in the state-owned power utili- goods. There seems to be no rationale for reduced ty—are prevalent in the rate structure for electricity VAT rates in border areas, so border rates should be use in housing and agriculture and are considered increased to the standard rate. The tortilla subsidy’s among the largest in the world. Subsidizing domestic 1990s elimination in favor of a cash transfer to lower energy consumption both encourages wastefulness income levels demonstrates the possibility of refor- and discourages investment in energy efficiency. And ming politically difficult fiscal benefits. despite being a net gasoline importer, Mexico sells mexico reform agenda for inclusive and sustainable growth 111 FIGURE 3. Mexico does not fully pass through the FIGURE 4. Subsidies have increased as a sharp increases in international gasoline prices result of the domestic fuel-price adjustments Mexico and US gasoline prices* Energy Subsidies as a percentage of GDP 14 3.5 12 3 10 2.5 1.8 8 2 6 1.5 0.1 0.7 0.4 0.4 4 1 1.2 1.2 0.9 2 0.5 1 1 1 0.9 0.9 0 0 0 0.1 0.22 0.1 0.2 -2 -0.5 -0.2 -0.6 -4 -1 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 -1.5 -1.2 2002 2004 2005 2006 2007 2008 2009 2010 Gap MX US Gas LP Electricity Gasoline (IEPS) * Magna price for Mexico and Regular Conventional Retail price for the US; in pesos/liter. Source: Thomson Reuters Datastream Source: Scott, John (2011) Quien se bene cia de los subidios energeticos en Mexico?, gasoline domestically at a much lower price than do sales revenue. At the same time, a sudden drop in most OECD and Latin American countries (figures oil prices and export revenue is not accompanied by 3 and 4). lower domestic sales revenue. Domestic fuel-price adjustments have not kept Removing energy subsidies would help Mexico up with international price increases. Mexico for raise revenues, avoid distorted price signals, and years followed a fuel-pricing policy of monthly price reach its climate change mitigation goals. The adjustments that until 2009 aligned with expected added revenue from the withdrawal of subsidies for inflation. But today, prices are adjusted at an acce- electricity use in housing and agriculture—along lerated pace, to close the growing price gap between with the adoption of a positive fixed excise tax on domestic and international prices. The difference fuel— could be used in part to mitigate the effect between the sales price to the public and the (in- of higher energy prices on lower income households. Managing Medium-Term Fiscal Challenges ternational) reference price is made up by a variable Additional transfers to beneficiaries of the Oportuni- excise tax that turned negative following the sharp dades program to compensate for higher energy prices rise in oil prices over the past few years. A negative in 2008 could be an efficient mitigation tool. Because excise tax equals a subsidy of the same size. reducing fuel subsidies at a time of high oil prices Fuel-pricing policies have served economic and would be politically difficult, a temporary option fiscal stabilization purposes in the past, but today could be to accelerate the price-smoothing mecha- there are better alternatives. Predictable, monthly nism for gasoline and diesel, to quickly align them price adjustments avoid the impact that international with international prices. Once a target excise tax on oil- and fuel-price volatility has on inflation elsewhe- fuel has been reached, fuel prices should be allowed re. This may have been important when monetary to fluctuate with international price movements. authorities were still battling to bring inflation down A fixed excise tax on fuel would increase the to levels in line with overall economic stability. With sensitivity of government revenues to energy inflation within the target range established by the price fluctuations and in turn, the importance of monetary authorities, the artificial suppression of a strong stabilization mechanism. Budget stability fuel-price volatility may no longer be needed, given and transparency would benefit from institutionali- the moderate impact on overall inflation and infla- zing the oil-price hedge and lifting the stabilization tion expectations. Similarly, the monthly fuel-price fund caps. Lifting the caps would create a more adjustment has moderated the impact of oil-price effective fiscal buffer against large negative shocks, volatility on public finances. Higher oil prices add oil by promoting greater savings during economic up- export revenue, but do not lead to higher domestic turns and periods of high oil prices. Further, greater mexico reform agenda for inclusive and sustainable growth 112 energy-related savings could help protect future all OECD countries, Mexico’s Gini coefficient falls generations instead of financing current government only slightly, from 0.515 before taxes to 0.509 after. consumption. The best solution would be to reform It falls a bit more, to 0.465, when including targeted the stabilization funds so that they not only protect social spending. For an average EU country, however, and stabilize the budget and the economy from the Gini coefficient falls from 0.46 before taxes and excess volatility but also increase savings for future transfers to 0.34 after, largely through transfers.11 generations. Institutionalizing the oil price hedge High inequality in Mexico is due partly to the would reduce the pressure to use these funds for failure of fiscal policy to perform its redistributive other needs, such as to meet budget shortfalls. function. While income taxes are generally pro- Adopting a structural balance rule could help gressive, high informality and high poverty reduce reduce the procyclicality of public spending under the share of income tax in the overall tax base.12 the current rule. The obligation to target the nomi- Easier-to-collect indirect taxes, such as VAT, are nal balance and reserve fund caps imply that public largely regressive. But using multiple VAT rates spending rises and falls with revenue fluctuations can achieve some progressivity, despite increasing linked to economic growth and oil revenue. This skepticism about their effectiveness in achieving re- results in a close correlation between changes in distribution objectives. (See Annex 1 for a discussion expenditures from one year to another and changes on progressivity.) in nonoil tax and oil revenues. A structural balance Despite better targeting of social spending, rule would also further smooth spending patterns. some programs in Mexico disproportionally A structural budget would allow for an endogenous benefit the higher income population deciles and response to changes in revenue deriving from the worsen inequality. Some programs are very progres- economic cycle while promoting fiscal discipline and sive, as the per capita public transfer falls with higher sustainability of the deficit and debt levels. income levels (as shown in a negative concentration coefficient). Others are less so, as the per capita public transfer rises with higher income levels (as shown in a Improving the distributional positive concentration coefficient; figure 5). As long impact of fiscal policy as the concentration coefficient is below the market income Gini coefficient, these transfers are only Mexico’s tax-benefit system does not improve moderately redistributive. Like energy subsidies, income equality as much as in other OECD coun- VAT exemptions and zero rating are in effect non- tries. While taxes lower income inequality in almost targeted consumption subsidies. The amount of the Managing Medium-Term Fiscal Challenges FIGURE 5. Concentration coefficients for selected programs, 2010 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 Oportunidades -0.54 IMSS - Oportunidades -0.47 Adultos Mayores -0.39 Seguro Popular -0.35 Procampo -0.33 Salud SSA -0.32 70 y mas -0.29 Programa Alimentario -0.29 Empleo Temporal -0.25 Subsidio Eléctrico Domestico 0.19 Becas (excl. Oportunidades) 0.2 Salud IMSS 0.24 Subsidio GAS LP 0.25 Subsidio Empleo 0.29 Subsidio Gasolina 0.33 Saludud ISSSTE 0.47 Pensiones 0.49 Scott, John (2010) "Gasto Público para la Equidad: del Estado Truncado hacia el Estado de Bienestar Universal "Mexico Evalua Woking Paper Series, Mexico City. Source: Scott 2010. mexico reform agenda for inclusive and sustainable growth 113 subsidy obtained depends on household spending from higher levels of tax collection and a removal of on the subsidized products, which tends to rise with energy subsidies must be evaluated in parallel to an income. Devoting a larger share of public spending increase in public spending capacity for more targe- (including tax expenditures) to programs with a ne- ted spending programs. Eliminating subsidies and gative concentration coefficient (or a small positive preferential tax regimes, along with a compensation one) would help make the tax-benefit system more mechanism for lower income households, could lead progressive13. to a net benefit in the income redistribution function The distributional incidence of individual fiscal of the tax-benefit system. A communication strategy interventions should be less of a concern than the for fiscal reform is needed to show the costs and overall distributional incidence of the tax-benefit benefits of the suggested policy options and to build system. The loss in purchasing power generated political consensus. Matrix of short- and medium-term policy reform options* Reform area Short-term options Medium-term options Fiscal reform Implement revenue-enhancing tax reform that broadens the tax base, simplifies tax filing, reduces tax Tax reform expenditures, and eliminates special regimes and preferential rates. (LR) Accelerate price adjustment for domestic fuel sales to align with Adopt a fixed excise tax on domestic fuel international prices (LR) . Energy pricing reform sales and allow prices to fluctuate with Reduce subsidies on electricity for international price movements (LR) use in housing and agriculture (LR) Managing Medium-Term Fiscal Challenges Compensatory programs: provide Measures to improve Strengthen capacity to estimate compensation for lower income distributional impacts of tax overall distributional incidence of households negatively affected by and energy pricing reforms the tax-benefit system (AR). tax and energy pricing reform (LR). Institutionalize oil-price hedge and Budget stabilization measures remove caps on stabilization funds (LR). Adopt a structural balance rule (LR). Prepare medium- and long-term Improved measurement of medium- Maintain and publish annually medium- budget projections and analyze term revenue and expenditure trends and long-term budget projections. (AR) fiscal reform options (AR). * LR= Legal reform; AR= Administrative Reform. Preliminary classification. mexico reform agenda for inclusive and sustainable growth 114 ANNEX 1. Fiscal policy and income redistribution: absolute versus relative progressivity 1 transfer: progressive in absolute terms Cumulative proportion of bene ts, taxes or income 45 degree line; transfer neutral in absolute terms tax: upper bound of regressive transfer: progressive in relative terms; tax: regresive transfer: regresive; tax: progressive market income Lorenz curve; transfer or tax: neutral in relative terms 0 0 1 Cumulative proportion of population (ordered by market income) \Analyzing the distributional impact of a tax or benefit on per capita income is essential for comparing policy options. If a government’s goal is to improve income distribution (lower inequality and poverty), it should allocate the largest share of spending to programs that are progressive in absolute terms. Transfers are progressive in absolute terms when their per capita value declines with market income. In the figure above, absolute progressive transfers are those above the 45-degree perfect-equity line. Cash-transfer programs, such as Oportunidades, are progressive in absolute terms, as the poor receive more transfers than the nonpoor in absolute terms. Transfers are regressive in absolute terms but progressive in relative terms when their per capita value increases with market income, while their value relative to the market income declines. Examples of these transfers, for which the concentration coefficient is positive but smaller than the Managing Medium-Term Fiscal Challenges market income Gini coefficient (reflected in the graph by a curve between the market-income Lorenz curve and the 45-degree line), are value added tax exemptions and zero rating on food and energy subsidies, as well as public spending on tertiary education. Taxes are called progressive and transfers regressive in absolute and relative terms when their relative value with res- pect to market income goes up. In this case, the line reflecting the distribution of the tax or transfer is below the market-income Lorenz curve (and the concentration coefficient is higher than the market income Gini coefficient). Source: Lustig and others 2011. mexico reform agenda for inclusive and sustainable growth 115 Notes 1 This amount reflects the budgetary public sector, including revenues generated by state-owned enterprises in energy and social security. 2 IMF, 2011, 2011 Article IV Consultation, p 32. 3 Seguro Popular was introduced in 2001 as a health insurance program for low-income households not covered by social security. In 2012, the government claimed full coverage of the population without social security. 4 The expansion of 70-plus also followed the creation of universal pension systems by a number of states and Mexico City. 5 Assuming 3.6 million people age 70 and older without a pension and a basic pension of 500 pesos a month. 6 See Criterios Generales de Política Económica (2012). 7 To compare Mexico’s tax base with that of other countries, the OECD includes transfers by PEMEX to the federal govern- ment, because if the oil company were a private enterprise, it would pay the equivalent in royalties. 8 However, tax rates are toward the lower end of the international spectrum. 9 Mexico’s Tax Administration Service (Servicio de Administración Tributaria) estimates that approximately 77 percent of income tax due on nonsalary income is not paid and that VAT tax evasion is estimated at 35 percent. 10 The individual maximum marginal rate was temporarily increased from 28 percent in 2010 to 30 percent in 2012 but will fall to 29 percent in 2013. 11 OECD, 2011. Economic Surveys: Mexico 12 The two richest income deciles pay almost 80 percent of income taxes and, as a result of an in-work tax credit, the three poorest income deciles pay negative income taxes on average. 13 Birdsall, Lustig, and McLeod 2011. References Birdsall, Nancy, Nora Lustig, and Darryl McLeod. 2011. “Declining Inequality in Latin America: Some Economic, Some Poli- tics.â€? CGD Working Paper 251. Center for Global Development, Washington, DC. Managing Medium-Term Fiscal Challenges Secretaría de Hacienda y Crédito Publico 2012. Criterios Generales de Política Económica. Mexico City, Mexico. IMF. 2011, Mexico 2011 Article IV Consultation Selected Issues, IMF Country Report No. 11/249, Washington, DC. Lustig, Nora, Carola Pessino, George Gray Molina, Wilson Jimenez, Veronica Paz, Ernesto Yanez, Claudiney Pereira, and Sean Higgins. 2011. “Fiscal Policy and Income Redistribution in Latin America: Challenging the Conventional Wisdom.â€? Eco- nomics Working Paper 1124. Tulane University, New Orleans, LA. OECD. 2011. Economic Surveys: Mexico, Paris, France. OECD, 2011. Revenue Statistics 1965-2010, Paris, France. Scott, John. 2010. “Gasto Público para la Equidad: Del Estado Excluyente hacia un Estado de Bienestar Universal.â€? Centro de Investigación y Docencia Económicas (CIDE), Mexico City, Mexico. Scott, John. 2011. “Quién se beneficia de los subsidios energéticos en México?â€?Centro de Investigación y Docencia Econó- micas (CIDE) y Consejo Nacional de Evaluación de la Política de Desarrollo Social, Mexico City, Mexico. mexico reform agenda for inclusive and sustainable growth 116 mexico reform agenda for inclusive and sustainable growth 119 Strengthening Public Revenue and Expenditure Management to Enhance Service Delivery Executive summary Message 1. Public service delivery is hindered by low tax collection and inefficient expenditure at the fede- ral, state, and municipal levels. On the revenue side, upgrading public service delivery requires improving tax administration and incentive frameworks, espe- cially in subnational governments. Message 2. On the expenditure side, Mexico needs to improve public sector performance and expenditure quality. Mexico lags behind its OECD peers on ma- nagement of key functions in the budget cycle—from planning to execution and evaluation. Under a new legal framework intended to increase expenditure efficiency, Mexico has made considerable progress in improving the quality of expenditures and of the decision making process on budget formulation and reallocation. Message 3. Mexico needs to strengthen public sector management systems, complete accounting harmonization, implement performance-informed budgeting, consolidate implementation of the new financial management system, and strengthen the federal procurement system. mexico reform agenda for inclusive and sustainable growth 120 Objectives To achieve higher growth and reduce poverty and inequality, Mexico needs to improve public service deli- very. Mexico is a middle-income country with continuing high levels of poverty (46.2 percent of the population) and inequality (a Gini coefficient of current disposable income close to 0.50). It has maintained macroeconomic stability over the past 15 years, a necessary but not a sufficient condition for growth and poverty reduction. To accelerate growth and reduce poverty, it needs to build the capacity of its public sector institutions to collect revenue and execute public programs effectively and efficiently. To improve public sector service delivery, Mexico needs to ensure sufficient financial and human resources relative to the needs of the population, and effective and efficient public management of spending programs to address those needs—two basic prerequisites for an effective public sector. Mexico’s public service delivery is hindered by low tax collection and expenditure inefficiencies at all three levels of government: federal, state, and municipal. Key challenges Mexicans’ trust in the state is among the lowest in Latin America (figure 1). Contributing factors are the uneven quality of public spending programs and low tax collection rates, reflecting taxpayers’ disappointment with the use of their taxes. Improving the quality of public spending programs should gradually enhance the perceived trustworthiness of the state. FIGURE 1. Citizens’ trust in the state, 2011 70% 62% 62% 60% 52% 51% 51% 48% 50% 40% 40% 39% 37% 37% 36% 36% 34% 34% 40% 31% 29% 25% 30% 18% 20% 10% 0% Uruguay Ecuador Panama Venezuela El Salvador Argentina Costa Rica LAC Brasil Paraguay Bolivia Colombia Nicaragua Chile Peru Mexico Honduras Dominican Rep. Guatemala Source: Latinobarómetro 2011 Revenue management Mexico’s tax collection is low by Organization for Economic Co-operation and Development (OECD) standards. Mexico has one of the lowest tax collection rates in the world. It has the lowest share of tax revenues to GDP in the OECD (figure 2).1 And its share of tax revenue (including oil income) was a little over half the OECD average in 2010 (18 percent of GDP compared with 33 percent). mexico reform agenda for inclusive and sustainable growth 121 FIGURE 2. Total tax revenues as FIGURE 3. Tax revenues for selected percentage of GDP, 2010 Latin American countries, 2010 30 Denmark 48 25 Germany 36 20 Average OECD 34 Spain 32 15 USA 25 10 Chile 21 5 Mexico 18 0 0 10 20 30 40 50 60 Total Tax Revenues Direct Taxes Indirect Taxes Argentina Brasil Chile StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery Colombia Mexico Source: UECD provisional data (2010). http://stats.oecd.org/ Source: Economic Commission for Latin America (CEPAL) (2010) Mexico’s tax collection is also low by Latin of both direct and indirect tax revenues (figure 3). American standards. It can be argued that com- Mexico has made substantial progress in tax ad- paring Mexico’s tax revenues with those of the ministration in recent years. Tax administration has OECD economies is unfair because of the income been a major policy priority, but weaknesses in tax gap between Mexico and those economies. But policy (such as the scope and amount of tax exemp- comparing Mexico’s tax revenues with those of tions) limit its effectiveness. Over the past few years, other Latin American countries (drawing on Eco- the country has modernized its tax administration, nomic Commission for Latin America data, which including by making intensive use of information te- measure tax collection rates more accurately than chnology, such as Internet-based tax declaration and OECD data) produces striking results: Mexico payment mechanisms. There has been a substantial has the lowest tax-to-GDP ratio and is well below reduction in value added tax (VAT) fraud. And as other Latin American countries in the collection part of the government’s strategy to increase nonoil FIGURE 4. State own revenues as a share of the total, 2010 (percent) 60 50 40 30 20 10 Tabasco Guerrero Chiapas Zacatecas Colima Oaxaca Aguascalientes Hidalgo Morelos Querétaro Durango Yucatan Sinaloa Michoacán Puebla Guanajuato Nayarit Tlaxcala Coahuila Tamaulipas Veracruz Baja California Sur Jalisco Baja California Sonora Mexico Campeche Chihuahua Nuevo Leon Quintana Roo Distrito Federal San Luis Potosí Source: Ministry of Finance and Public Credit [2010] (SHCP) mexico reform agenda for inclusive and sustainable growth 122 revenues, changes were made to the fiscal code in collection and reduce discretionary transfers. Stron- 2009 to improve tax administration and enforcement. ger incentives are needed for the states, for example The problem of low tax collection is particu- by building on the one that the Tax Administration larly acute at the local level, as many subnational Service (Servicio de Administración Tributaria) intro- governments lack incentives and administrative duced under the Régimen de los Pequeños Contribu- capacity. At the local level, improving tax collection yentes (For more details on proposals to raise federal faces additional challenges. First, many small and and subnational tax revenue see Mexico Policy Notes medium-size municipalities suffer from low insti- 9 and 10). tutional and administrative capacity, and local tax collection teams lack the tools, training, and systems to implement corrective actions related to key tax Expenditure management administration functions (tax revenue collection, enforcement, and audits). Second, states depend on Mexico needs to improve public sector perfor- federal transfers for most of their revenue (figure 4), mance and the quality of expenditures. Budget so they have little incentive to focus on improving and financial management covering key functions tax collection. in the budget cycle, from planning to execution to StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery Low subnational tax collection increases the evaluation, have traditionally focused on process volatility of subnational finances within Mexico’s compliance and input control. These functions and fiscal federalism framework.2 During the recent systems need upgrading to provide public sector economic slowdown and drop in oil prices, federal managers and decision-makers with relevant, ti- public finances were partially protected from exoge- mely, high-quality information on financial inputs nous shocks by the government’s fiscal risk mana- and outputs and on outcomes from public projects gement strategy (mainly the oil hedging program). and programs. This challenge requires actions on However, the amount of federal revenues shared with several fronts: implementing modern harmonized subnational governments fell dramatically. Mexican accounting standards and performance-informed states thus faced greater external risk than did the budgeting policies, using information technologies federal government, and subnational public finances more intensively for public sector management (e- were hit hard. government), raising standards of administrative Subnational governments need incentives and procedures and procurement, and strengthening the assistance to improve their tax administration capacity of federal and subnational governments to to increase own revenues. Subnational tax admi- deliver high-quality public goods and services in a nistration functions are in general weak, with low timely fashion. A modern financial management institutional capacity and inadequate collection system and harmonized accounting standards would and enforcement processes. Key areas needing to allow proper financial management, costing, execu- be strengthened are transitioning from manual to tion, control, and transparency of federal, state, and electronic tax collection systems, moving to a single municipal public programs, increasing accountability tax registry, enforcing tax collection through a more to the public and Congress and contributing to an efficient taxonomy of cases and subjects, enhancing open government. Information on the performance tax audit capacity and the human resources devoted of public programs and policies would enable the to tax auditing, implementing information mana- government to measure progress toward its goals, gement systems with a wide range of performance revealing which public programs are working and indicators and better information databases, and which are not, and giving decision-makers some carrying out business process reengineering of state impartial information on the performance of de- administrations, particularly for property and payroll partments, agencies, and programs. taxes. Also crucial are consistency in property valua- Although Mexico has developed a new legal tion techniques, support to cadastre management and framework to increase expenditure efficiency, the improved inter-agency coordination for property tax country still lags behind its OECD peers on key administration (including property registry, public functions of budget management. Remaining notaries, and construction licenses). In addition to challenges include strengthening cash management promoting better tax administration capacity, the and harmonizing budget information on public ex- federal government could promote incentives for tax penditures, revenues, debt, and contingent liabilities mexico reform agenda for inclusive and sustainable growth 123 at both the federal and state levels. The Performance and actions to results-based budgeting, the reforms Evaluation System (Sistema de Evaluación del Desem- should help achieve announced public policy goals. peño, or SED), anchored in a new legal framework Simplifying expenditure execution procedures and affecting all three levels of government, defining budget execution and procurement processes will in new policies on results-based management and turn contribute to more effective programs and ser- results-based budgeting. The new legal framework vice delivery. Implementing performance-informed includes the 2007 Fiscal Reform, which details the budgeting requires a cultural change that implies a SED framework; the 2008 Constitutional Reform very different budget management style, particularly on Expenditure, which requires all levels of govern- in a federal system with sovereign states. ment to adopt results-based budgeting, performance Mexico has strengthened budget discipline by evaluation, and multiyear budgeting for investment improving budget management across the budget projects; the Ley de Fiscalización y Rendición de Cuen- cycle, from planning through execution to audit tas de la Federación, which regulates and strengthens and evaluation. The new legal framework has been oversight of government accounts (cuenta pública) followed by specific actions and the adoption of po- and includes newly defined performance audits as licy reforms in line with best international practice: part of the oversight function; and the Ley General de the conceptual model for the financial management StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery Contabilidad Gubernamental (LGCG), approved in information system (Sistema Integral de Adminis- December 2008, which dictates the rules underlying tración Financiera Federal, or SIDAFF), approved government accounting and financial information by the Ministry of Finance in July 2009, began with a view to harmonizing all levels of government implementation in 2012; the General Accounts Plan and decentralized government institutions. (Plan General de Cuentas), approved by the Ministry Several key actions have been taken to institu- of Finance in September 2010; the General Govern- tionalize this legal framework. Critical measures ment Accounting Manual (Manual General de Con- include integration of the SED, including the deve- tabilidad Gubernamental), approved in November lopment of methodologies, guidelines, and procedu- 2010; the Government Accounting Manual for the res for its implementation (2008); implementation Executive Branch (Manual de Contabilidad Guber- of budgetary programs and their alignment with namental para el Poder Ejecutivo); and the reforms performance indicators (2008–11); integration of for implementation of the treasury single account. performance information with budgeting to inform With these reforms, plus the fiscal and expenditure decisions about program and activities (2011 bud- reforms, budget management is expected to become get); and design of the Evaluation and Fiscal Trans- a policy and planning tool, and SIDAFF will be able parency Unit in the Ministry of Finance and Public to produce real-time reports, thereby strengthening Credit (2011) and of a Performance Evaluation and budget control, accountability, and transparency. Fiscal Transparency System (2011). Under this legal In 2009, the Ministry of Public Administration framework, the Ministry of Public Administration created the Management and Government Per- (Secretaría de la Función Pública, or SFP) is implemen- formance Evaluation Unit to guide and lead its ting the Special Program for Management Improve- internal efficiency effort. The PMG is being imple- ment in Federal Public Administration (Programa mented throughout the entire federal government. Especial de Mejora de la Gestión en la Administración In 2010, the federal government approved nine Pública Federal, or PMG; 2008–2012). Also critical regulations standardizing the internal public admi- have been consolidation of the Evaluation Council nistration procedures that all federal government (CONEVAL), development of an evaluation pro- agencies should use for auditing, procurement, con- gram for federal transfers (Ramo 33) to subnational trol, financial management, human resources, asset governments (2011), and development of key prin- management, information technology, transparency, ciples for implementing the performance-informed and accountability. This reform eliminated 3,549 budgeting agenda at the subnational level. Imple- regulations in federal administration. The PMG will menting these reforms at all levels of government also improve public sector management efficiency by is expected to enhance public sector performance, simplifying and standardizing external regulations improve the expenditure quality, increase public and procedures for 10 key public services. The PMG, sector accountability, and enhance fiscal discipline though it has had some impact and has been able to and sustainability. By linking government finance mobilize resources, has not been consolidated as a mexico reform agenda for inclusive and sustainable growth 124 cross-cutting tool to enable better public sector ma- evaluations have been completed, and the results nagement across agencies. A number of fundamental are starting to inform resource allocation through cross-cutting public sector reforms (not addressed the budget process. The evaluations have also served in this note) remain to be addressed—for example, as the basis for creating an evaluation capacity and civil service and regulation simplification. Over the culture within the federal government. The challen- coming years, the government needs to either con- ge now will be to clarify the process of generating solidate the PMG effort or consider an alternative and using evaluations. Currently, the law provides implementation strategy. competencies for generating evaluations to three The performance budgeting and evaluation institutions—CONEVAL, the Ministry of Public system3 reform led by the Ministry of Finance has Administration, and the Ministry of Finance—crea- advanced a results- and performance-informed ting potential competency conflicts and uncertainty orientation in the federal budget process. To in- on who will do what (aside from the general rule that corporate results and performance dimensions into CONEVAL focuses on social programs). Program resource allocation, the new system uses performan- discussion during budget preparation and program ce indicators for public sector programs, along with redesign remains informal, and mechanisms need to systematic evaluation of public sector policies and be developed to provide incentives for good program StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery programs. The Ministry of Finance has developed performance. Finally, it is essential to institutionalize guidelines with standardized logical framework the evaluation function to move forward and conso- instruments for federal government entities to use in lidate the reform. formulating their strategic plans. Performance indi- Mexico has also achieved substantial progress cators were developed for each program, and recently in fiscal transparency. After a broad consultation the Ministry of Finance also developed a complex and participatory process involving specialized methodology to synthesize, prioritize, and monitor nongovernmental organizations and experts, and in federal government programs using results and per- collaboration with the regulatory entity for access to formance information. Budget classifications used in information (Instituto Federal de Acceso a la Informa- budget allocation have been adjusted and expanded ción y Protección de Datos), the Ministry of Finance to facilitate effective monitoring and accountabi- launched a fiscal transparency portal to detailed lity of government programs, allowing for effective information on the allocation and use of federal results-informed budget deliberations (even though government resources. The portal includes a citizen- implementing the programmatic classification is still friendly application—city budget (presupuesto ciuda- a pending issue). Consolidating performance-based dano)—that facilitates access to budget information budgeting at the federal and state level depends and describes the budget process in a very accessible on consolidating the SIDAFF and equivalent state way. The initiative has been successful, but if it is to financial management systems, completing the contribute fully to improving citizens’ trust in gover- harmonization agenda, improving the quality of the nment, it needs to be consolidated, scaled up, and performance information, institutionalizing the eva- explicitly linked to the action plan on open gover- luation function, and working with sector ministries nment. At the state level, progress has been uneven; to consolidate the performance culture, implement accounting harmonization will be a prerequisite to the new tools and processes, and expand capacities further progress. to use them. As part of an ambitious strategy to modernize The Ministry of Finance recently established public sector financial management, the govern- a specialized function for comprehensive evalua- ment has started to harmonize the public accounts tion of selected federal government policies and and accounting practices of the federal and sub- programs. Based on an annual evaluation plan, the national governments. Because results-informed Ministry of Finance commissions evaluations that management requires mechanisms for accounting, analyze government programs: conceptualization, reporting, and consolidating information, accounting technical approach and design, efficiency and effecti- systems are being modernized and harmonized. At the veness in implementation, achievement of intended federal level, the Ministry of Finance has developed a objectives, and impact. The evaluations highlight new conceptual model to integrate core public finan- positive aspects of each program and point out defi- cial management functions (budget, treasury mana- ciencies and areas for further improvement. Several gement, and accounting) and related administrative mexico reform agenda for inclusive and sustainable growth 125 procedures (human resources, procurement, use and The key challenges are to consolidate the current sys- maintenance of assets and materials, and provision of tem and to target more areas. Especially important services) as the basis of SIDAFF. Besides providing a is continued emphasis on performance outcomes. common framework and instruments for integrating Because the risk of waste and corruption in procu- core public financial management functions within rement systems is known to be high, procurement the Ministry of Finance, SIDAFF helps simplify and reform and monitoring can yield substantial gains harmonize activities across the federal government, for the economy and society. emphasizing back-office functions. Mexico aims to align its public procurement Completing the accounting harmonization system more closely with expenditure policy to program will remain a challenge for the next ad- generate value for money, ensure transparency and ministration. This task, not simply technical, will efficiency, and improve the quality of the works, require strong political leadership to ensure that the goods and services procured. Over 2009–11, ope- accounting and reporting changes are implemented rational changes and amendments to the legal and as the basis for effective resource management in the regulatory framework have addressed several weak- public sector. At the subnational level, the Ministry nesses. Among the most important reforms are in- of Finance has developed guidelines for the accoun- troducing framework agreements and reverse auction StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery ting harmonization; supporting the country’s 1,200 mechanisms, establishing a more comprehensive role smaller and less developed municipalities must re- for the electronic procurement management system, main a priority. In partnership with the government’s Compranet (including the possibility of electronic technology department and complemented by an bidding), addressing some of the bid-opening pro- ambitious capacity-building program, the Ministry cedures, and establishing a non-judicial conciliation of Finance needs to do more work on developing process. By reducing red tape and improving the ma- the new web-based solution for modernizing, har- nagement of public sector operations, these reforms monizing, and consolidating municipal financial are expected to improve public service delivery. information using a common platform. Finally, the Ministry of Finance needs to prepare guidelines for decentralized entities and state-owned companies at the federal level and develop the consolidation Policy options model and associated instruments for automated integration and consolidation of public accounts On the revenue side, subnational governments at all government levels and for the production of need incentives and assistance to improve their tax consolidated accounting reports for the entire public administration to increase own revenues. There is sector, following international best practices. a blueprint to guide further reforms of tax adminis- Improving the efficiency of government deli- tration at the federal level, but more work is needed very of goods and services requires continuing the at the subnational level, where tax administration procurement system reform that begun in 2009. functions are in general weak. Problems include Mexico’s public procurement system has a large im- low institutional capacity and poor collection and pact on the country’s economy: public procurement enforcement processes. Several key areas would be- accounts for 40 percent of the federal budget and nefit from federal support to state governments (see about 10 percent of GDP, and the estimated savings below). from effective procurement are substantial.4 Until On the expenditure side, Mexico needs to recently, the procurement system was overregulated, strengthen its public sector budget management focused heavily on the administrative function, and functions, focusing on performance in formula- based primarily on legal regulations. The electronic ting, executing, and evaluating public spending procurement system was outdated by 2009, incapable programs. Mexico has made good progress on three of improving transparency, generating competition, main fronts of its public sector modernization agen- or streamlining processes. In addition, procurement da: harmonizing accounting at the federal and sub- staff lacked both knowledge and professionalism. national levels, introducing performance-informed Recent efforts have resulted in savings for the gover- budgeting, implementing SIDAFF and the treasury nment and have improved delivery of works, goods single account, and building on the success of pro- and services, but further improvements are needed. curement reform in centralized government and mexico reform agenda for inclusive and sustainable growth 126 sector delivery units to strengthen core public sector The federal government needs to complete the management functions. However, further actions are implementation of SIDAFF’s systems and apply needed to strengthen those core functions, particu- the accounting manual principles throughout the larly at the subnational level. As experience from government, including in state-owned enterprises. other countries shows, setting up a performance- Going forward, the key issue is to preserve the role, informed system requires a cultural change, with a effective application, and maintenance of SIDAFF. new management style based on performance incen- That makes it critical to reach the so called “point of tives, management delegation, and a focus on inputs, no returnâ€?—the implementation strategy milestone outputs, and outcomes. that secures all those requirements through the end On procurement, the legal, institutional, and of the current administration and the six years of the operational frameworks must remain dynamic next. It is thus important to have in place a program and responsive to the challenges in the market as to advance ownership and effective application, new technologies and ways of doing business arise with proper indicators. The program should include in Mexico and elsewhere. The transformation of strengthening the staff capacity of the Government the procurement system has strategically targeted Accounting Unit (Unidad de Contabilidad Guberna- key legal, institutional, and operational aspects. mental e Informes para la Gestión Publica, UCGIGP). StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery Legal reforms involved amending procurement law In addition to having an implementation strate- (2009) and secondary legislation (2010–11) and gy and building political and technical consensus, eliminating many internal regulations. Institutional political leadership, training, and dissemination and operational changes strengthened the roles and strategies are key to the successful implementa- capabilities of the Ministry of Public Administration tion and sustainability of SIDAFF. Establishing a with the development of a Procurement Intelli- strong fiscal accounting culture will protect all the gence Unit,5 improved stakeholder engagement, a products developed under SIDAFF (accounting procurement certification process for procurement manual, guides, functional specifications, and system professionals, and process standardization and sys- integration) and implemented after years of pains- tem improvements in the e-procurement platform, taking preparation. Continuing training and com- Compranet. Future short- and medium-term policy munication activities will complement the sound reforms should focus on achieving greater efficiency accounting rules. The training has to be done within and best-value-for-money outcomes, and increasing UCGIGP and the rest of the Ministry of Finance, competition and transparency by shifting procure- including the Oficialías Mayores and the rest of the ment toward performance outcomes. federal administration. Progress on performance-based budgeting At the subnational level, it will be important to requires progress on accounting harmonization. A provide support and incentives for implementing strong financial management system, as envisioned state-level financial management systems consis- by SIDAFF and the accounting harmonization tent with the accounting harmonization. For states agenda, is fundamental to performance-based and municipalities, establishing a common budget budgeting. Pursuing the agenda of the Accounting classification system in parallel with accounting Harmonization Council (CONAC) and consolida- harmonization would enhance fiscal transparency ting performance-based budgeting will be critical. and support standardization across levels of gover- However, CONAC’s ambitious agenda needs to be nment. Fiscal transparency at the subnational level revised to ensure smooth implementation, and an would promote accountability and fiscal consoli- enforcement mechanism needs to be established sin- dation. In addition, a more transparent accounting ce there is no incentive mechanism to truly engage framework would improve expenditure monitoring the states. In addition, evaluation functions—inclu- and encourage efficiency. The Ministry of Finan- ding those of CONEVAL, the Ministry of Finance, ce and CONAC7 will be important if SIDAFF and the Ministry of Public Administration6—need implementation at subnational level is to continue to be clarified and consolidated. Finally, Mexico according to the LGCG. Incentive mechanisms for should continue working on its open budget/gover- subnational governments that adopt an integrated nment transparency agenda, a proven tool for citizen system, and support to those that are willing to move influence on service delivery standards in other forward with the requirements of the LGCG, will be countries. important through 2013. mexico reform agenda for inclusive and sustainable growth 127 Matrix of short- and medium-term policy reform options* Policy area Short-term options (1 year) Medium-term options (2–3 years) · Implement a more ambitious tax · Transition from manual to electronic revenue reform (LR, see Policy Note 8). tax revenue collection systems. (AR) · Move toward a single tax registry (AR). · Improve management of collection · Implement information management enforcement through a more efficient systems with a wide range of performance Improve tax collection taxonomy of cases and subjects (AR). indicators and better databases (AR). and administration · Enhance tax audit capacity and increase · Improve consistency in property valuation related human resources (AR) techniques, cadastre management, · Carry out business process reengineering and interagency coordination (AR). of state administrations (AR). · Promote incentives for tax collection and reduce discretionary transfers (AR). StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery · Implement CONAC’s agenda with a realistic framework that facilitates and enforces implementation at the state level (AR) · Consolidate evaluation functions and clarify evaluation competencies among CONEVAL, the Ministry of Finance and Public Credit, and the Ministry of Public Administration (AR). · Implement and consolidate performance- Improve quality of public · Institutionalize the specialized unit informed budgeting reforms across sectors expenditure: public into a formal evaluation unit within and coordinate with the accounting financial management, the Ministry of Finance (AR) harmonization agenda and SIDAFF (LR). accounting harmonization, · Clarify the process and roles for using · Strengthen public sector budget and performance- evaluations in program redesign (AR). management functions to gradually move informed budgeting · Continue to implement the to a performance orientation (LR). treasury single account (AR). · Develop training and dissemination strategies for SIDAFF (AR). · Provide support and incentives for subnational implementation of SIDAFF (AR). · Advance the open budget/government transparency agenda (AR). · Conduct risk and benefit assessments of the market and suppliers (AR). · Professionalize the procurement workforce. (AR) · Support the Procurement Intelligence · Introduce management tools and functions Improve quality of public Unit and Compranet (AR) (such as monitoring and evaluation, expenditure: procurement · Review the legal framework for civil data collection, performance indicators, works, goods, and services (including and outcome evaluations). (AR) framework agreements, reverse auctions, and standardization process). (LR) *LR=Legal Reform; AR=Administrative Reform. Preliminary Classification mexico reform agenda for inclusive and sustainable growth 128 Notes 1 OECD data combine property tax collection with proceeds from state-owned enterprises, which tend to overestimate Mexico’s collection rate. 2 See World Bank policy note “Subnational Public Finances in Mexico: Main Challenges and Possible Solutions.â€? 3 The Presupuesto Basado en Resultados y Sistema de Evaluación del Desempeño (PBR-SED). 4 Unidad de Política de Contrataciones Públicas, Política General de Contrataciones Públicas, 2012. 5 Unidad de Políticas de Contrataciones Públicas, Subsecretaría de Responsabilidades Administrativas y Contrataciones Públicas, Ministry of Public Administration. 6 The law designates CONEVAL, the Ministry of Public Administration, and the Ministry of Finance as the public entities to coordinate evaluations. CONEVAL covers evaluations for social programs, and the Ministry of Public Administration and the Ministry of Finance cover the other evaluations for public programs. Having these competencies dispersed across three major players is a valid yet sometimes confusing framework. 7 The LGCG created CONAC, which has issued most of the harmonized accounting instruments for the government StrengtheningPublicRevenueandExpenditureManagementtoEnhanceServiceDelivery accounting system required to implement the law. References Latinobarómetro. 2011. OECD (Organisation for Economic Co-operation and Development), OECD Stats extracted on 29 May 2012. http://stats. oecd.org/ CEPAL (Economic Commission for Latin America) Statistics (2010). mexico reform agenda for inclusive and sustainable growth 129 mexico reform agenda for inclusive and sustainable growth 131 Strengthening Subnational Public Finance Executive summary Message 1. Mexico’s intergovernmental transfer system needs to reduce vertical imbalances and discretionary federal transfers. The dependence of Mexico’s states on federal transfers has increased dramatically and now amounts to about 90 percent of subnational public revenue. These vertical im- balances, combined with the rise in discretionary federal transfers, have lessened the states’ incentive to raise their own revenue. The fiscal federalism reform should focus on addressing these challenges. Message 2. Mexican states need to raise more of their own revenues and improve the transparency and efficiency of expenditures. A salient characte- ristic of the Mexican fiscal federalism framework is the states’ low level of subnational tax effort (about 10 percent of GDP compared with 20 percent in Bra- zil). At the same time, subnational expenditures (half of the country’s total public expenditures) have been growing rapidly and now constitute two-thirds of to- tal subnational public expenditures. The rise in state expenditures is partly explained by growing societal needs. But it is also the result of unfunded mandates that emerged from an incomplete fiscal decentraliza- tion process. This problem is compounded by limited budget flexibility, as most of the subnational revenues are earmarked federal transfers. In addition, there is a need to standardize subnational budgets and increase their transparency. Message 3. Mexico’s subnational borrowing fra- mework could be strengthened to improve fiscal discipline. The borrowing framework relies on market mechanisms, as reflected in the state credit risk premium charged by private lenders. While successful in keeping subnational debt at low levels (about 2.5 percent of GDP, compared with 10 per- cent in the United States), the framework has not prevented fiscal distress. Subnational debt has risen rapidly since 2008. The lack of fiscal discipline has led to unsustainable fiscal positions in some states. This calls for fiscal consolidation programs that combine financing (conditional on fiscal and service delivery targets) with technical assistance to mobilize the states’ own revenues and improve expenditure mana- gement. And it calls for a transparent crisis resolution mechanism for states that fall into fiscal distress. mexico reform agenda for inclusive and sustainable growth 132 Objective This note assesses Mexico’s pending subnational fiscal reform agenda. Mexico is a federal country divided into 31 sovereign states and one federal district. Each state is composed of municipalities. The fiscal federalism framework in this three-tier government structure consists of the set of laws, rules, and institutions that alloca- te spending and tax responsibilities and of the transfers and institutional framework for the subnational debt. Mexico has made great progress in strengthening its fiscal federalism framework over the past 10 years, but there is room for improvement. The pending Mexican fiscal federalism reform should focus on decreasing the large vertical gaps that states face, increasing local revenue mobilization, increasing the transparency and effectiveness of local expenditures, and strengthening the subnational borrowing framework to improve states’ fiscal discipline. Key challenges The federal transfer system faces vertical imbalances and a growing discretionary component The Mexican federal transfer system is affected by growing vertical imbalances. States depend heavily on federal transfers to cover their expenditure needs and debt obligations. Federal transfers account for about 90 percent of Mexican states’ revenues. There are three types of federal transfers: federal tax revenue shares (participa- ciones), which represent about 38 percent of states’ revenues; federal grants earmarked for mandated expenditures (aportaciones), amounting to about 40 percent of states’ revenues; and ad hoc federal transfers for sector-specific expenditure agreements (convenios), which make up about 10 percent of subnational revenues. Participaciones were set up to “reimburseâ€? tax revenues to states, whereas aportaciones emerged as a response to the Mexican expenditure decentralization process. Figure 1 shows the amount of transfers going to Mexican states.1 Richer states tend to receive higher non-earmarked transfers. This is consistent with the reimbursement principle (principio resarcitorio), which assigns more resources to states that contribute a greater amount to the federal tax pool.2 Aportaciones are more progressive, as suggested by the positive slope of the trend-line (though there is a lot of variability around the trend). A recent evaluation from CONEVAL suggests that the allocation of FIGURE 1. Richer Mexican states tend to receive larger participaciones, whereas aportaciones tend to be more progressive—though there is great variation around the trend 2011 Participaciones per capita 2011 Aportaciones per capita (Pesos) (MX Pesos) 6500 7500 6000 7000 5500 6500 6000 5000 5500 4500 5000 4000 4500 3500 4000 3000 3500 2500 3000 DF COAH QRO SON AGS CHIH JAL DGO SLP YUC EDOMEX HGO TAB MICH TLAX OAX DF NL COAH QROO QRO CAM SON BCS AGS TAMPS CHIH BC JAL COL DGO SIN SLP GTO YUC MOR EDOMEX ZAC HGO PUE TAB VER MICH NAY TLAX GRO OAX CHIS Source: Ministry of Finance and Public Credit (SHCP). mexico reform agenda for inclusive and sustainable growth 133 aportaciones could be improved (see Policy Note 5). rate over 2005–10 was about 6 percent). Their share Convenios are sector-specific expenditure agre- in total revenues currently stands at about 12 percent, ements that opened up the possibility of additional which is still lower than in other countries in the discretionary transfers from the federal government. region such as Argentina (17 percent) or Colombia Convenios play an increasingly important role in the (30 percent). The increase in subnational revenues Mexican intergovernmental transfer system (figure after 2000 was partly due to stronger economic acti- 2). They are determined according to agreements vity and partly to an increase in the number of taxes signed throughout the budget year between state collected by subnational governments (an increase in governments and federal government agencies. This their tax base). For example, by 2000, 23 of 32 states arrangement opens up the possibility of additional collected the payroll tax; by 2009, all 32 states did. discretionary transfers from the federal government to State-specific information reveals some degree the states. In addition, other, less transparent venues of heterogeneity among Mexican states. The Fede- for providing additional financial assistance to states ral District and a few other states (Baja California exist: taxes condoned, social security contributions (for Sur, Chihuahua, and Nuevo Leon) show a higher federalized teachers insured with the federal ISSSTE), tax effort. But the share of own-revenues collected or payments of public services (such as electricity by other states is very low, representing less than or water fees). The amount of annual discretionary 5 percent of total revenues in Guerrero, Nayarit, transfers and financial assistance provided to states Oaxaca, Puebla, Tabasco, and Tlaxcala). The share of is increasing, though exact information is difficult to own-revenues is lower than 7 percent for more than obtain. These discretionary transfers soften the budget a third of Mexican states (figure 3). constraint that subnational governments ought to face Mexican states surrendered their most valua- to avoid excessive spending financed out of a common ble taxing powers to the federal government in pool of resources. Rather than raise their own revenues, 1980. The states gave up their ability to tax income control expenditures, or even borrow from the markets, and commercial activities and allowed the federal states have the incentive to lobby for more resources. government to impose an income tax (ISR) and a value-added tax (VAT).3 The aim of the reform was to improve tax collection efficiency, unify the tax Low level of states’ own-revenues authority, and reduce tax evasion. In exchange, the federal government agreed to share revenues with States’ own-tax revenues have increased in recent subnational governments. This was the origin of the years but are still low. Own-tax revenues moderately current system of participaciones (non-earmarked Strengthening Subnational Public Finance increased over the past few years (the average growth transfers to subnational governments). FIGURE 2. Convenios have been growing fast in recent years Convenios to Own-State Revenues (%) Convenios to Total State Revenues (%) 85.0 7.5 80.0 7.0 75.0 6.5 70.0 65.0 6.0 60.0 5.5 55.0 50.0 5.0 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 Fuente: Secretaría de Hacienda y Crédito Público (SHCP) e Instituto Nacional de Estadística y Geografía (INEGI) mexico reform agenda for inclusive and sustainable growth 134 FIGURE 3. Subnational own-revenues increased recently but remain low. Own-revenues are less than 7 percent of total revenues for more than a third of Mexican states Own Revenues/Total Revenues (%) 2010 Subnational Revenue Composition 45 100% 40 90% 35 80% 30 70% 25 60% 20 15 50% 10 40% 5 30% 0 20% -5 10% DF CHIH BCS NL EDOMEX QRO QROO GTO National SON BC VER CAM SIN HGO TAMPS DGO AGS JAL COL CHIS MOR SLP COAH YUC ZAC MICH OAX OUE TAB GRO NAY TLAX 0% TABS DGO GRO SIN HGO CHIS QRO YUC CAM MICH National ZAC NAY CHIH NL VER DF Own revenue/ Total revenues Ratio 2010 Federal Transfers Own Revenues 2005-2009 Growth Own Revenue Financing Other Source: Ministry of Finance and Public Credit (SHCP). Today, the largest tax handle for Mexican states a dramatic reduction in the amount of federal reve- is the payroll tax. The payroll tax accounts for almost nues shared with subnational governments. While 80 percent of state tax revenues, and states are free federal public finances were partly protected from to set the tax rate. But rates are rather homogeneous exogenous shocks because of the government fiscal across the states, at around 2 percent; in Baja Cali- risk management strategy (for example, the oil hed- fornia Sur and the State of Mexico, the rate is higher, ging program), Mexican states were defenseless and at 2.5 percent. The “local tenenciaâ€? (on cars older than subnational public finances were hit hard.4 10 years) and the lodging tax are also relatively im- portant (even if much less than the payroll tax). The “federal tenenciaâ€? (on car ownership and use) and the Subnational expenditures have Strengthening Subnational Public Finance ISAN (on new cars) are “federally coordinated.â€? This been on the rise and should be means that tax rules (including the definition of the more transparent and efficient tax base and the determination of the tax rate) are set by the federal government, but states collect these Subnational expenditures have been growing in taxes and keep the proceeds. The special tax on ga- recent years. They currently constitute more than soline and diesel fuel (fixed fee per liter), which was half of total public expenditures (figure 4). During introduced in 2008, has similar features. Its base and the 1990s spending powers were largely transferred rate are determined by the federal government), but from the federal government to states and muni- it is administered by the states, which keep all of the cipalities. In 1992 Mexico’s federal government proceeds collected from this tax. Overall, the amount decentralized primary education, effectively trans- collected through “federally coordinatedâ€? taxes is ferring to the states the responsibility to finance similar to what is collected through the payroll tax basic education. This implied also transferring the and therefore constitutes a critical source of revenue teachers’ large wage bill. In 1996 health services for Mexican states. were decentralized to the states, too. Expenditure The low level of subnational tax effort is one of pressures kept increasing in recent years (up 100 the main vulnerabilities of the fiscal federalism percent during the last decade). The rising cost of framework in Mexico. States’ dependence on fe- state retirement plans will create additional pres- deral transfers constitutes a severe vulnerability, as sures. They currently represent 2.3 percent of total confirmed by the Lehman crisis. The slowdown of retirement accounts in the country but are projected economic activity and the drop in oil prices led to to increase during the next decade. mexico reform agenda for inclusive and sustainable growth 135 FIGURE 4. Subnational expenditure responsibilities increased and led to significant vertical imbalances Subnational Expenditure / Total Public Expenditure Expenditure (2010) (MXN billion, 2010 prices) 1400 1300 1200 1100 Subnational 1000 Expenditure 900 52% 800 700 600 500 400 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Ministry of Finance and Public Credit (SHCP) and National Institute of Statistics and Geography (INEGI). Source: Ministry of Finance and Public Credit (SHCP). States' Operational Expenditures as a Percentage Expenditure/Own-Revenue Ratio of Ordinary Fiscal Revenue 45 11.5 40 82 35 11 80 30 78 10.5 25 76 20 10 74 15 72 10 9.5 70 5 68 0 9 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 Bottom 3: PUE+ TLAX + YUC Top 3: BCS+ HGO + SLP National Source: Fitch Ratings. Source: Ministry of Finance and Public Credit (SHCP). Strengthening Subnational Public Finance Greater expenditure management efficiency is Subnational debt is also on the rise needed to gradually reduce the burden of current and some states are in fiscal distress expenditures as well as budget rigidity. States’ current expenditures have been increasing in recent The global financial crisis severely affected the years. According to Fitch data, operational expendi- amount of federal transfers to subnational govern- tures (defined as current expenditures and transfers) ments. The decrease in oil prices meant significantly increased from MXN 300 billion in 2007 to MXN lower oil revenues, which are shared between levels 370 billion in 2010. On top of that, some recurrent of government. In addition, the subdued level of expenditures (such as social transfer programs) economic activity implied a significant reduction in have been classified as part of the state investment federal tax revenues,5 which are also shared. Overall, program. The large and increasing amount of ope- the combined impact of these shocks implied signi- rational expenditures limits states’ budget flexibility. ficantly reduced transfers for subnational entities and To address this issue, the increasing trend of current created an aggregate gap in their balances of about 70 expenditures needs to be reversed by increasing the billion pesos (three times the amount accumulated efficiency of expenditures (for example, in education). in the FEIEF, the “rainy dayâ€? fund created through annual federal surplus revenues). To fill the gap created by high expenditures and lower revenues, subnational governments borrowed resources from commercial banks and debt levels increased. Subnational debt showed a mexico reform agenda for inclusive and sustainable growth 136 particularly strong increase in the period following debt service payment. With this aim, shared federal the Lehman crisis. Subnational debt registered by tax revenues (participaciones) have often been used SHCP amounted to MXN 390.8 billion ($30.0 as the denominator, because these resources are billion) by the end of 2011 after increasing at an not earmarked for the use of specific expenditures annual rate of nearly 20 percent in real terms since or in predetermined sectors. According to SHCP, 2008. Over 2001–08 subnational debt had expanded the average level of subnational debt as a percentage at a much more moderate average annual pace of 6 of participaciones increased to 79 percent in 2011 percent in real terms. after hovering around 50 to 55 percent over the past Subnational borrowing capacity has shrunk decade.6 since the global crisis. Compared with GDP, Subnational debt is high and has been growing aggregate subnational debt in Mexico appears low rapidly in some Mexican states. To assess subnatio- relative to international standards since it accounts nal indebtedness levels, it is essential to go beyond for about 3 percent of GDP, well below its share in national aggregate figures (which are still relatively countries such as Argentina, Brazil, and the United low) and consider state-specific situations. Figure 5 States (7, 12, and 19 percent of GDP, respectively). shows that heterogeneity is high and has increased However, in view of the limited ability of subna- since the Lehman crisis (the coefficient of variation tional governments to impose taxes, the debt-to- is equal to 80 percent, up from 64 percent in 2008). GDP statistic can be misleading, and subnational In some states the debt to participaciones ratio is very borrowing capacity is probably better measured by low (such as Campeche or Tabasco) and/or has de- comparing subnational debt with the percentage of creased during the last three years (Estado de Mexico, subnational revenues that can be used or pledged for Oaxaca, and Sinaloa). But there are states where debt FIGURE 5. Subnational debt significantly increased over the last three years, particularly in some states Total Subnational Debt Short-term Debt Evolution (MXN billion, 2011 Prices) 27 43 500 41 26 400 39 25 37 Billion pesos 300 24 35 Percent 33 Strengthening Subnational Public Finance 200 23 31 22 100 29 21 27 0 20 25 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 July 09 Oct 09 Jan 10 Apr 10 July 10 Oct 10 Jan 11 ST debt/Total banking credit ST debt Average National Debt/Participaciones (%) Debt/Participaciones Ratio in Each State (%) 350 100 300 79 80 250 60 200 150 40 100 20 50 0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -50 COAH QROO NL CHIH NAY MICH SON DF VER BC JAL CHIS TAMPS DGO COL MEX AGS ZAC BCS SLP PUE GTO SIN OAX MOR HGO GRO YUC QRO CAMP TABS TLAX 2011 2008-2011 Growth Source: Ministry of Finance and Public Credit (SHCP). mexico reform agenda for inclusive and sustainable growth 137 exploded after the Lehman crisis (such as Coahuila Policy options and Quintana Roo) and became a significant source of vulnerability. In several states, the growth of subnational debt Raise subnational own-tax effort was driven by the increase of short-term debt. In Mexico, state legislatures have the right to define Subnational governments in Mexico should what constitutes debt. Most states do not consider raise more taxes. Higher subnational tax efforts liabilities whose maturity is less than a year to be would have several advantages, including: impro- debt. This has had important consequences. If the ving the resilience of Mexican states to exogenous state definition of debt does not include short-term shocks; reducing the dependence on oil-related debt, the contracting of debt does not need to be revenues, which are projected to decline; prepa- approved by the local congress. If short-term debt ring states to face the growing burden of retire- is not officially considered as debt, it can be used to ment benefits; and increasing subnational states’ finance current expenditures. In addition, the 2009 capacity to repay their debt (thus lowering the modification of bank prudential regulations exemp- borrowing costs). ted short-term debt from a higher risk rating and the Several strategies could be considered to need to establish prudential reserves.7 Consequently, achieve this objective. Improving tax admi- short-term debt increased significantly during the nistration would offer states an opportunity to past two years (figure 5) and the rapid accumulation raise more revenues. In addition, states could levy of short-term liabilities resulted in unsustainable surcharges on a tax defined and administered by debt levels and fiscal problems in some states (such the federal government. Another option is to as Coahuila). improve property tax collection. Property taxes Nonregistered short-term debt led to growing are the ideal tax at the subnational level of go- discrepancies between debt included in the federal vernment, as the tax base cannot be shifted easily debt registry and actual subnational debt. This from one jurisdiction to another. The collection issue became particularly relevant for states such of property tax (which is levied at the municipal as Chihuahua, Coahuila, Michoacán, Tabasco, and level) is very low (0.2 percent of GDP compared Zacatecas. In Coahuila the actual amount of debt with an average for OECD countries of almost 10 turned out to be four times higher than the amount times as much). Mexican states could be involved registered in SHCP. As a result, in 2011 its financial in strengthening property tax collection for their distress took the authorities and market participants municipalities. Strengthening Subnational Public Finance by surprise, partly because there was misreporting Political economy factors complicate states’ and underreporting of the state’s debt and partly incentives to increase tax collections. For politi- because these loans were not considered when moni- cal reasons, it is difficult for states to raise or even toring loan concentration. maintain tax collection levels (especially when The lack of complete and reliable information taxes are closer to the voters). The recent expe- on subnational entities’ liability position raised rience with tenencia offers a clear example of these questions regarding the borrowing framework. political limitations. In 2007 the federal govern- Credit ratings were used by bank regulators to as- ment proposed to transform the federal tenencia sign capital risk weightings and prudential reserves and gave states five years to enact local tenencia for bank loans to subnational governments. But the laws. Notwithstanding the importance of this tax, overdependence on rating agencies, and decreased many states decided to repeal it, particularly those regulation of short-term debt, reduced due diligence having elections. Political disincentives could be by some financial institutions and led to fast debt managed through the imposition of “federally growth and high lending concentrations. The bo- coordinated taxes.â€? But beyond political reasons, rrowing framework was recently improved. In Sep- states’ incentives to raise more taxes are also li- tember 2011 the government modified banking re- mited by the possibility of receiving discretionary gulation, linking prudential reserve requirements for transfers, which soften the budget constraints that lending to subnational entities with a comprehensive states should face. A hard budget constraint is set of indicators. However, additional reforms are essential to promoting fiscal consolidation at the still needed. state level. mexico reform agenda for inclusive and sustainable growth 138 Improve the transparency and efficiency in teacher salaries. Negotiations on wages take place of subnational expenditures at the federal level, but the additional fiscal burden is borne by the states. Limited control of spending Fiscal transparency would promote accountability negatively affects expenditure efficiency. and efficiency of subnational expenditures. The importance of state expenditure responsibilities requires the standardization of the classification Improve subnational fiscal discipline of states’ budgetary expenditures. Currently, sub- national budgetary reporting is not homogenized. The intergovernmental federal system requires Teacher payrolls are a clear example. According to better defined procedures for crisis resolution as the National Institute of Statistics and Geography, an alternative to the ad hoc federal transfers. A state teachers’ payroll may be filed under “Personal framework for state insolvency could be developed Servicesâ€? or “Transfersâ€? in official public finance sta- to provide incentives to good practices in exchange tistics. States report spending less than 20 percent of for federal assistance. This may take the form of their budget on payroll. In reality, a large part of the federally supported subnational fiscal adjustment payroll is filed under transfers. The Mexican Institute plans, in which fiscal and service delivery targets for Competitiveness estimates that, due to the lack are set on measures to expand revenue, rationalize of transparency, hidden payroll costs amount to 4 expenditures, or restructure public debt. Fiscal ad- percent of GDP. It is critical to make expenditure justment plans would be accompanied by transfers reporting more transparent to verify the actual des- or loans from the federal government conditioned tination of earmarked transfers and promote accou- on the implementation of the program. The main ntability and efficiency of expenditures. Classifying differences with the current practice of ad hoc federal all payrolls under Personal Services (Chapter 1000) additional transfers may include the conditioning would constitute a step in the right direction. of the financial support and the transparency with A clearer distinction between federal and state which the program is implemented. expenditure responsibilities, especially in the basic A more transparent debt reporting is also nee- education sector, could improve service delivery. ded to strengthen subnational fiscal discipline. Education is the main area that presents an issue Strengthening debt data accuracy and particularly, of overlapping responsibilities. The decentralization the automatic inclusion of short-term debt in the of expenditures for this sector, and in particular for definition of state debt would be a relevant policy basic education, is often criticized. Even though reform. The establishment of a common budget Strengthening Subnational Public Finance states continue to have limited responsibilities in classification system in parallel with the harmo- implementation or actual delivery (as norms and nization of accounting across government levels financing are determined centrally), they perceive is also required to enhance transparency and fiscal significant expenditure pressures generated by this discipline (see Mexico Policy Note on Public Sector decentralization. An example is provided by increases Modernization). mexico reform agenda for inclusive and sustainable growth 139 Matrix of short- and medium-term policy reform options* Reform area Short-term options (1 year) Medium-term options (2–3 years) · Reduce discretionary transfers · Review the subnational borrowing framework Improve subnational to subnational states (LR) to include a crisis resolution mechanism fiscal discipline · Include short-term debt in the in case of state’s fiscal insolvency (LR) definition of debt for all states (LR) · Strengthen tax administration at Raise subnational · Impose federally coordinated taxes (such as the subnational level (AR) own-revenues ISAN) to promote state own-revenues (LR) · Strengthen property tax collection efforts by states (LR). · Standardize subnational · Harmonize accounting of state Improve transparency and budgetary reporting (LR). payroll expenditures (LR) efficiency of expenditures · Distinguish clearly between state and federal expenditure responsibilities (LR). *LR=Legal Reform; AR= Administrative Reform. Preliminary classification. Notes 1 The income ranking for these charts is based on non-oil mining GDP per capita. Standard state’s GDP figures carry a distortion due to the fact that a large share of the offshore oil production is assigned to Campeche. When GDP except oil mining is used, Campeche moves from the first to the fifth position. 2 This trend is gradually evolving. In recent years, the “regressivityâ€? of participaciones was gradually diluted, as shown by the decreasing steepness of the participaciones trend-line (see the red line in figure 1). Strengthening Subnational Public Finance 3 In 2009 these two taxes represented about 80 percent of Mexican public sector tax revenues. 4 This example underlines the importance of having a fiscal risk management strategy in place. States could consider designing a fiscal risk management strategy to smooth the flow of federal transfers. 5 Federal non-oil tax revenues during 2009 decreased 10.5 percent in real terms. 6 More recently, SHCP has started to integrate a series which broadens the definition of subnational resources that can be used and pledged for debt service payment, including state and local government own-revenues (local taxes and fees) and part of federal transfers for basic infrastructure. Using such a broader denominator, subnational debt increased to an average of 61 percent of subnational governments’ available revenue in 2011 from 41 percent in 2007, according to SHCP data. 7 The 2011 reform of banking regulations addressed this specific issue. mexico reform agenda for inclusive and sustainable growth 140 THE WORLD www.banc:omwullaLorg.-. -....-BANK