Report No. 29145-GT Country Economic Memorandum Economic Country Guatemala Report No. 29145-GT Report No. 29145-GT Guatemala Country Economic Memorandum Challenges to Higher Economic Growth Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

March 9, 2005

Central America Department Latin America and the Caribbean Region Public Disclosure Authorized Authorized Disclosure Disclosure Public Public Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

Document of the Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

EGEE Empresa de Generacion de Energia ElCctrica EMAX Empresa Municipal de Aguas de Xelaju EMPAGUA Empresa Municipal de Agua ENCOVI Encuesta de Condiciones de Vida ENSMI National Survey on Maternal and Child Health ETCEE Empresa de Transmisibn y Control de Energia ElCctrica FDI Foreign Direct Investment FENACOAC Federacion Nacional de Cooperativas de Ahorro y Credit0 FFBC Fiduciary fund to help finance mergers and acquisitions offinancia institutions FONACYT Fondo Nacional de Ciencia y Tecnologia FONDETEL Fondo para el Desarrollo de la Telefonia (Rural Telephone Fund) FOPA Deposit insurance fund FTA Free Trade Agreement FTAA Free Trade Area ofthe FTZ Free-Trade Zone FUNSIN Association created to raise funding for engineering research projects GATT General Agreement on Tariffs and Trade GDP GNP Gross Nacional Product GTM Guatemala GUATEL Empresa Guatemalteca de Telecomunicaciones HHI Herfindahl-Hirschman Index IAAC Inter-American Accreditation Cooperation ICA Investment Climate Assessment ICAITI Instituto Centroamericano de Investigacion y Tecnologia Industrial ICs Investment Climate Survey ICT Information and Communication Technologies IDA International Development Association IDB Inter-American Development Bank IGSS Guatemalan Social Security Institute IMAE Indice Mensual de la Actividad Economica IMF International Monetary Fund INCAE Instituto Centroamericano de Administracion de Empresas INDE Instituto Nacional de Electrificacion INDECOM Association for Consumers Defense INECIP Instituto de Estudios Comparados en Ciencias Penales y Sociales INFOM Institute of Municipal Promotion INTECAP Technical Institute for Training and Productivity IPR Guatemala’s Rights IPR Intellectual Property Rights IS0 International Organization for Standardization ITU International Union IV Instrumental Variables LAC Latin America and the Caribbean MAGA Ministry ofAgriculture, Livestock, and Food MCIV Ministry ofCommunication, and Housing MDG Millennium Development Goals MEM Ministry ofEnergy and Mining MFA Multilateral Fiber Agreement MFIs Microfinance Institutions MFN Most Favored Nation MINUGUA Mision de Verificacion de las Naciones Unidas en Guatemala MSE Medium and Small Enterprises MSPAS Ministry ofPublic Health and Social Action NAFTA North America Free Trade Agreement NEU New Unitary Schools NGO Non-Governmental Organization NIS National Innovation System NSST National System of Science and Technology NTB Non- Barriers OECD Organisation for Economic Co-operation and Development OGA Guatemalan Accreditation Organization OLS Ordinary Least Square PAOT Technological supply adaptation plan PAYSA Proyecto de Agua Potable y Saneamiento del Altiplano PC Personal Computer PEC Programa de Extension de Cobertura PER Rural Electrification Plan PNC Nacional Civil Police PPA Power Parchase Agreement PRONADE National Program ofEducation R&D Research and Development RAMOS Reproductive Age Mortality Studies RCA Revealed Comparative Advantage REDIMIF National microfinance industry association RER Real Exchange Rate RGP Registro General de la Propiedad RIC Registro de Information Catastral S&T Science and Technology SAC Central American Tariffs System SAT Superintendencia de Administracih Tributaria SEGEPLAN General Secretary ofPlanning SENACYT National Secretary of Science and Technology SIAF Sistema Integrado de Administracih Financiera SIECA Secretariat for Economic Integration ofCentral America SIMA World Bank's Statistical Information Management & Analysis SINCYT Sistema Nacional de Ciencia y Tecnologia SME Small and Medium Enterprise TELGUA Telecomunicaciones de Guatemala, S.A. TELMEX Telefonos de , S.A. TFP Total Factor Productivity TFPG Growth ofTotal Factor Productivity TIMSS Trends in International Mathematics and Science Studies TIMSS-R Trends in International Mathematics and Science Studies - Repeat TRIPS trade-related aspects ofintellectual property rights UNCOMTRADE Commodity Trade Statistics Database UNDP United Nations Development Programme UNEPAR Unidad Ejecutora del Programa de Acueductos Rurales UNESCO- United Nations Educational Scientific, and Cultural Organization OREALC Regional Office for in Latin America and the Caribbean UNICEF United Nations Children's Fund UNICRI United Nations Interregional Crime & Justice Research Institute UPOV Intemational Union for the Protection ofNew Varieties of Plants USAC Universidad de San Carlos de Guatemala USAID Agency for Intemational Development USTR United States Trade Representative VAL Value Added per Worker VAT Value-Added W&S Water and Sanitation WB World Bank WBES World Business Environment Survey WDI World Development Indicators WEF World Economic Forum WHO World Health Organization WIPO World Intellectual Property Organization WTO

GUATEMALA COUNTRY ECONOMIC MEMORANDUM

Table of Contents

EXECUTIVE SUMMARY AND RECOMMENDATIONS ...... i

RESUMEN EJECUTIVO Y RECOMENDACIONES ...... xx

Chapter I: INTRODUCTION STYLIZED FACTS AND DETERMINANTS OF GROWTH ...... 1 I. Introduction ...... 1 I1 Background ...... 1 A . General Context ...... 1 B. Historical Economic Performance...... 3 C . Policy Reforms ...... 8 D. Recent Developments ...... 9 E. Near Term Outlook and Macroeconomic Concerns ...... 12 I11 Accounting for the Sources of Economic Growth...... 14 A . Growth Accounting ...... 15 B. The Factors Contributing to Growth...... 19 IV. Growth, Reduction and Inequality ...... 23 V . Conclusion ...... 27

Chapter 11: HUMAN CAPITAL AND GROWTH IN GUATEMALA ...... 30 I. Introduction ...... 30 I1 The State of Human Capital Development in Guatemala ...... 31 Education ...... 31 Health and Nutrition ...... 40 I11. Structure of the Labor Force ...... 46 IV. Human Capital, Productivity, and Growth in Guatemala ...... 49 Education ...... 49 Health and Nutrition ...... 55 Inequality in Human Capital and Growth...... 56 V . Implications for Policy ...... 56 Completion the Unfinished Primary Education Agenda - Raising Primary School Quality, Retention and Completion Rates ...... 57 Strengthening People’s Productive Capacity Through Better Nutrition ...... 58 Expanding Access to and Participation in Secondary Education ...... 59 The Issue of Skills Training ...... 60 Financing Human Capital Development for Growth...... 60 V . Conclusion ...... 63

Chapter 111: THE INVESTMENT CLIMATE IN GUATEMALA ...... 65 I. Introduction ...... 65 I1 The Investment Climate in Guatemala: An Overview ...... 65 I11. The State of Governance ...... 70 IV. Crime and Violence ...... 80 VI. Infrastructure 86 ...... Telecomunication...... 86 Electricity...... 90 Logistic: Transport, Ports and Customs ...... 94 Ports ...... 97 Customs ...... 100 Water and Sanitation ...... 101 VI. Financial Sector Development...... 105 Market Structure and Performance ...... 107 Legal and Regulatory Issues ...... 109 VI1. Policy Recommendations ...... 111

Chapter IV: TECHNOLOGY PERFORMANCE AND POLICY IN GUATEMALA...... 115 I. Introduction ...... 115 I1 Technology. Absorption. Diffusion and Generation ...... 115 I11. Looking for Possible Causes: Skills and Labor Training: the National System of Quality and the National Innovation System...... 119 Skills and Labor Training ...... 119 The National Quality System ...... 122 The National Innovation System ...... 124 IV. Policy Options ...... 136

Chapter V: TRADE AND GROWTH IN GUATEMALA ...... 141 Introduction ...... :...... 141 Review ofTrade Policies ...... 144 Import Tariffs ...... 144 Non Tariffs Barriers ...... 144 Free Trade Zones ...... 145 International Free Trade Agreements and Preferential Regimes...... 145 Exchange Rate Policy ...... 147 Summary and Evaluation...... 148 CAFTA Implications For Guatemala ...... 149 The content of CAFTA...... 149 Potential Impact ofCAFTA for Guatemala...... 155 Impact on Agriculture ...... 156 Impact on Manufactures...... 157 Impact on Investment ...... 159 Impact on Public Finances ...... 159 Recommendations: Actions to Maximize CAFTA Opportunities ...... 160 Text Tables Table 1. 1. GDP Growth Rates in Guatemala and LAC ...... 4 Table 1.2. Guatemala: GDP Structure - 1951.2002 ...... 5 Table 1.3. Guatemala: GDP Growth Rates ...... 6 Table 1.4. Variation of GDP...... 6 Table 1.5. Guatemala: Contribution to Output Growth...... 15 Table 1.6. Changes in Per Capita Growth: : 1990s vs . 1980s ...... 19 Table 1.7. Difference Between Actual and Predicted Growth Early 90s vs . Late 80s . 19 Table 1.8. Alternative Long Term Growth Scenarios (Percentages per annum) ...... 20 Table 1.9. Guatemala - Projected Evolution of Poverty Headcount Indicators Under Alternative Growth Assumptions ...... 21 Table 1.10. The Key Determinants of Growth in Guatemala: 2000-2010 ...... 22 Table 1.1 1 Growth and Distribution Growth Rates Required to Reduce Poverty by Half between 2000 and 20 15 (average rate ofchange. 2004-2015) ...... 24 Table 2.1. International Comparison ofKey Education Indicators ...... 34 Table 2.2. International Comparison ofKey Health Indicators ...... 42 Table 2.3. Returns to Education and Training. 2000...... 51 Table 2.4. Estimated Long-Run Elasticities of Growth with Respect to Education...... 53 Table 2.5. Guatema1a:Decomposition of GDP Growth. by Level ofEducation. 1951-2002 ...... 54 Table 2.6. Guatemala: Decomposition ofGDP Growth, by Level ofEducation. and Adjusted for Quality ofCapital. 197 1-2002 ...... 54 Table 3.1. Human Resources and Performance of the Judiciary System in Selected Countries ...... 78 Table 3.2. Budget ofthe Judicial System in Guatemala ...... 80 Table 3.3. Guatemala Average Rates for Calls in the Fixed Lines services (2003) ...... 87 Table 3.4. Internet Users in Central America (September. 2003) ...... 87 Table 3.5. Market Structure of Telephone Sector. June 2002 ...... 89 Table 3.6. Average Electricity Price per kwh in Central America. June 2003 ...... 92 Table 3.7. Road Performance in Guatemala and Benchmarks ...... 94 Table 3.8. Guatemala’s Port Activity. 2002 ...... 98 Table 3.9. Guatemala’s Port Activity ...... 99 Table 3.10. Water and Sanitation Service and Coverage ...... 101 Table 3.11. Water Rates in Central America...... 102 Table 3.12. Coverage ofUtilities (Service by Service. proportion ofhouseholds) ...... 104 Table 3.13. Banking System in Central America. end-2003 ...... 106 Table 3.14. Selected Banking Sector Indicators in Central America, 2003 ...... 106 Table 3.15. Microfinance Industry in Central America ...... 109 Table 3.16. Financial Soundness Indicators - September 2003 (in percent) ...... 110 Table 4.1 IS0 Certification and Industrial Activity ...... 117 Table 4.2. ICT Indicators in Guatemala and Benchmarks, 2002 ...... 118 Table 4.3. Indicators of Labor Force Qualification ...... 118 Table 4.4. Average Time to Fill a Vacancy, 2003 ...... 120 Table 4.5. Public Expenditures Registered as S&T in Guatemala’s Executed Budget ..... 125 Table 4.6. Firms’opinion about R&D incentives, 2001 ...... 128 Table 4.7. Annual Funding Sources ofUSAC’s Centro de Investigaciones de Ingenieria...... 128 Table 4.8. Firms’opinion about domestic competition in Guatemala. 2001 ...... 129 Table 4.9. Firms’opinion about intellectual property protection , 2001 ...... 129 Table 4.10. Participation of Guatemala to International Intellectual Property Treaties ...... 131 Table 4.1 1. SME Development Mechanisms for Technology and Information in Selected LAC countries ...... 132 Table 4.12. Firms’ opinion of the quality ofresearch institution, 2001 ...... 132 Table 4.13. State of Cluster Development, 2001 ...... 133 Table 4.14. Competitiveness Assessment of Central America (2002-03) ...... 136 Table 4.15. Technology Extension Services in Selected Countries ...... 139 Table 5.1. Trade Flows as percentage of GDP ...... 143 Table 5.2. Average Tariff Rates in CACM Countries ( in percentage) ...... 144 Table 5.3. Mutual Access to Sensitive Markets After CAFTA ...... 150 Table 5.4 Guatemala: Comparative Advantage and Barriers to Trade in the US for Agricultural and Agroindustrial products ...... 157 Table 5.5. Guatemala: Estimated Effects of US Tariff Eliminations ...... 158

Boxes Box 1.1 Measures to Improve Income Distribution in Latin America ...... 25 Box 1.2 Drivers of Rural Growth in Guatemala...... 29 Box 2.1 On-the-Job and Skills Training Programs in Guatemala ...... 40 Box 2.2 Multiple Measures of Malnutrition...... 43 Box 3.1 Concession Experience in Guatemala...... 97 Box 3.2 The Modelo Basico ...... 103 Box 3.3 Rural Infrastructure ...... 104 Box 4.1 Labor Training in Guatemala : the INTECAP...... 123 Box 4.2 R&D at the firm level: evidence from Firm Surveys ...... 126 Box 4.3 A Successful example of cluster in Guatemala: the case of the cane industry ...... 135 Box 5.1 The Lessons from NAFTA...... 162

Figures Figure 1. 1. Guatemala - Growth Rates of GDP and GDP per Capita...... 4 Figure 1.2. GDP Growth Rates ...... 9 Figure 1.3. Growth Rates of GDP USA and IMAE* .Quarterly ...... 10 Figure 1.4. Current Account Deficit Percent of GDP) ...... 11 Figure 1.5. Real Interest Rate (Lending) ...... 12 Figure 1.6. Growth Trends in Guatemala, 199 1-2003...... 12 Figure 1.7. Central America, Real Effective Exchange Rates (1 997=100) ...... 14 Figure 1.8. Growth Performance in Central America - 1960-2000 ...... 16 Figure 1.9. Rates of Capital Growth ...... 17 Figure 1.I 0. Cormption Perception Index in Latin America and the Caribbean, 2000-2002 23 Figure 2.1. Net Enrollment Rates in Primary, Basic Secondary, and Diversified Education, 199 1-200 1...... 32 Figure 2.2. Primary and Secondary School Completion Rates, 1989 -2000 ...... 33 Figure 2.3. Primary Completion Rates for Non-IDA Countries in Latin America and the Caribbean (2001-2002) ...... 34 Figure 2.4. Basic Secondary Completion Rates for Non-IDA Countries in Latin America and the Caribbean ...... 35 Figure 2.5. School Quality According to Employer’s Appraisal. 2000 ...... 36 Figure 2.6. Primary Net Enrollment Rates, by Quintile. 2000 ...... 37 Figure 2.7. Secondary Net Enrollment Rates, by Quintile. 2000 ...... 37 Figure 2.8. Primary and Secondary School Completion Rates. by Quintile. 2000 ...... 38 Figure 2.9. Additional Years of Schooling. 1989-2000 (Population 25-65 yrs . of age) .... 39 Figure 2.10. Attendance in Job Training Courses. by Quintile. 2000 ...... 40 Figure 2.11. Chronic Malnutrition in Children under 5 yrs of age. 1987-2001...... 44 Figure 2.12. Chronic Malnutrition in Children under 5 yrs . By Quintile. 1999...... 45 Figure 2.13. Changes in Prevalence of Chronic Malnutrition in Children Under 5. by Quintile. 1995-1999 ...... 45 Figure 2.14. Structure of Output in Guatemala. 1990-2001...... 48 Figure 2.15. Sectoral Structure of Employment. 1991 and 2000 ...... 49 Figure 2.16. Education Spending as a Proportion of GNP. 1999-2000...... 61 Figure 2.17 Public Health Spending as a Proportion of GNP 2000 ...... 61 Figure 3.1. Number ofEnterprise Inspections per Year ...... 66 Figure 3.2. Number of Days to Register a Business (Doing Business Data base) ...... 66 Figure 3.3. Longest Time in Last Year to Clear Customs ...... 67 Figure 3.4. Labor Productivity: Guatemala and Comparators...... 67 Figure 3.5. Percent of Respondents Ranking Obstacles as Major or Severe ...... 68 Figure 3.6. Percent of Sales Value Paid Informally to Public Officials ...... 68 Figure 3.7. Percent of Management Time Spent Dealing with Public Officials. Regulation ...... 69 Figure 3.8. Leading Constraints by Formality ...... 70 Figure 3.9. Governance Indicators - Latin America and Caribbean and Guatemala (2002) ...... 72 Figure 3.10. Governance Indicators - Central America (2002) ...... 73 Figure 3.1 1. Central America Countries for Software Piracy: 1994- 1999 ...... 76 Figure 3.12. Violent Deaths. 1995-2002 ...... 82 Figure 3.13. Monthly Violent deaths. 2000-2002 ...... 82 Figure 3.14. Telecommunications in Guatemala ...... 86 Figure 3.15. Electrification Coverage 1995-2002 ...... 90 Figure 3.16. Centro America Coverage (1990-2002) ...... 90 Figure 3.17. Electricity Generators and Distributors ...... 94 Figure 3.18. Credit to Private Sector (%of GDP) ...... 105 Figure 4.1. Imports of Capital Goods. evolution 1997-2001 ...... 116 Figure 4.2. Trade Flows (exports + imports) ...... 116 Figure 4.3. FDI in Guatemala and Selected Countries ...... 117 Figure 4.4. Evolution ofthe number of patent applications in Guatemala ...... 119 Figure 4.5. Domestic Patents Granted to residents and level of development -2001 ...... 119 Figure 4.6. Level of Scientists and Engineers in research and development - latest available year 1996 -2002 ...... 124 Figure 4.7. R & D Expenditures per worker - 1995 ...... 126 Figure 4.8. Leading the way for Guatemalan firms to acquire technological innovation, 2003 ... 133 Figure 5.1. Guatemala : Trade as YOof GDP ...... 142 Figure 5.2. Guatemala : Direction of Merchandise Imports and Exports (average 2000- 2002) ...... 146 Figure 5.3. Textile Imports to the U.S...... 147 Figure 5.4. Guatemala Real Exchange Rate Index 1990=100 ...... 148 ANNEX A. The Key Determinants of Growth in Guatemala

REFERENCES

This study was led by Eduardo Somensatto, the Country Manager and Economist for Guatemala (LCC2GT) with the assistance of Maria Concepcion Castro on the basis of contributions from many participants and the collaboration of many Govemment agencies. The preparation of each chapter was the responsibility of Eduardo Somensatto, Chapter I;Andrew Mason (LCSHS), Chapter 11; Paulo Guilhermo Correa (LCSFR), Chapters 111 and IV; and Ricardo Tejada, LCCZC, Chapter V. Background papers were prepared by Ana Lucia Armijos, LCSPE (on the financial sector); Ludger Loening from the Ibero American Institute for Economic Research of the University of Goettingen (Human Capital and Growth); the Centro de Investigacion y Estudios Nacionales (CIEN) through Hugo Maul, Sigfrido Lee (Macroeconomic developments and Growth). Other inputs were received from Nicolas Peltier, YPP (on Infrastructure), Pilar Sanchez, LCSFP, Isabel Sanchez Garcia, LCSFP (on Innovation and Technology), Geeta Batra, CICFA, (on Investment Climate Assessment), Jorge A. Muiioz, Bemice K. Van Bronkhorst, Juan Miguel Crivelli and Patrick Kann. The study received considerable guidance and input from Carlos Felipe Jaramillo, Lead Economist for Central America. The peer Reviewers were Daniel Lederman, LCRCE, and Roberto Garcia Saltos, IMF. The preparation of the document was possible with the support of Annabella Lucas, the rest of the staff in the World Bank Guatemala nffirp and Snnia (1. Molina at Headoirarters GUATEMALA COUNTRYECONOMIC MEMORANDUM THE CHALLENGES TO RESTOREHIGHER ECONOMIC GROWTH

EXECUTIVESUMMARY

A. INTRODUCTION i. The purpose of this Country Economic Memorandum (CEM) is to contribute to the ongoing discussion in Guatemala about means of accelerating economic growth to help achieve targets set in the 1996 Peace Accords as a key ingredient in the fight to reduce national poverty rates. In this latter respect, it complements another recent World Bank study (Poverty in Guatemala, 2002), which, inter alia, identified the need for higher and more sustained economic growth as a critical element of consistent poverty reduction.

11. The CEM offers a diagnosis of the causes behind the stagnation of growth over much of the last decade - and particularly the period since 2000, when increases in per capita incomes all but stalled - and lays out recommendations concerning policy directions and priorities for the short- and medium-term aimed at helping to unleash the considerable potential of Guatemala’s economy. Chapter Iexamines historical and recent developments and uses a benchmarking growth methodology to identify the measures and policies most conducive to increasing long-term economic growth. Those areas that are identified as critical on the list of priorities are developed further in separate chapters. Chapter I1 focuses on the important role of human capital development for growth, along with the complementary policies for improving education and health. Chapter I11 examines the “investment climate,” broadly understood, which includes governance, access to infrastructure, and financial development. Chapter IV analyzes the importance of innovation and technology adaptation for productivity growth. Chapter V looks at trade openness and the catalytic role that the recently negotiated free trade agreement with the U.S. (CAFTA) could have on the Guatemalan economy.

B. COUNTRYCONTEXT ... 111. As has been well-documented by Guatemalan and external analysts, socio- economic development in Guatemala for much of its modern history has been severely affected by the country’s prolonged civil strife, which deepened social divisions and ushered in insecurity, fear, and mistrust. This, in turn, has seriously weakened social capital, thwarted the emergence of transparent, legitimate institutions and negatively affected governance and the rule of law. In terms of long-term economic impact, perhaps the greatest consequences ofthe conflict were displacement of over 1/12th of the country’s population (upwards of one million people), extremely high poverty and inequality and low investment in human development, especially among rural and indigenous people. iv. Today, despite a per capita income of $1,740, placing it in the ranks of middle income countries, Guatemala exhibits very poor social indicators relative to other countries in the sub-region. Education attainment is extremely low (3.5 years of schooling on 11 average), net enrollment in secondary school is less than 25 percent, and the illiteracy rate continues to be very high, in excess of 25 percent of the population. Health indicators are similarly poor, with extremely high rates of maternal and infant mortality, high malnutrition, and less than two-thirds of the population with access to basic health services.

V. In terms of broad economic trends, Guatemala has roughly followed the patterns evident in the rest of Latin America, with growth falling off in the 198Os, as a result both of disruptions caused by the internal conflict and the exhaustion of the early phase of import substitution. With the return to democracy in the mid 198Os, the country embarked on a period of economic reforms, including of the trade regime and financial markets in the 1980s and early 1990s respectively. Since the mid-l990s, reforms have focused on enabling greater private sector participation in the provision of key services, e.g., in the power and telecommunications sectors. While Guatemala made only limited progress in expanding trade in the 199Os, the aggregate numbers hide important changes, with a booming maquila sector and a dynamic nontraditional export sector (e.g., flowers, seasonal vegetables, fruits, and organic crops) coupled with declining traditional agro- exports yielding a more diversified trade basket.

vi. I The above gains in economic diversification have reduced economic (and export) volatility in Guatemala but have not, thus far, yielded high growth rates. Since 1996, the Guatemalan economy has grown at the somewhat disappointing rate of 3.3 percent per annum on average, far short of the Peace Accords target of 6 percent annual growth. Growth has been especially slow over the last four years, reaching only 2 percent in 2003 versus population growth of 2.7 percent per annum. The resulting decline in GDP per capita, and possible increase in poverty has, however, been blunted by a sharp rise in which flow mainly to rural families, acting as an important safety net. Aggregate consumption has also been cushioned by external financing flows to the private sector, enabling large and growing current account deficits in recent years. vii. Recent economic deceleration is due both to external and internal factors. On the external front, key factors have been a sharp decline in the price ofcoffee and a decline in demand for key exports as a result of the slowdown of the US economy. On the internal front, while macro-fiscal policies were broadly sound, unstable macroeconomic conditions between 1998 and 2000 restricted aggregate demand, while the intense conflict between the previous administration and significant segments of the private sector led to a deterioration of governance and the investment climate, leading to reduced foreign and domestic investment. In addition, Guatemala failed to continue with the reforms begun in the late eighties, lagging in the important goal of strengthening public institutions. viii. The gradual dissipation ofthe negative external shocks of recent years, led by the pickup in the U.S. demand for Guatemalan imports, sets the stage for a gradual recovery of growth, as already witnessed by the 2.7% rate achieved in 2004. In 2005 and 2006, the economy should continue to improve, as external demand from trading partners firms up (especially from the U.S.), and as investment is attracted by the prospects of the upcoming free trade agreement with the U.S. (CAFTA) and deepening regional integration efforts. The recovery should also be fueled by the improvement in business sentiment that has ... 111 been associated with administration of President Berger. Nevertheless, the rebound is unlikely to be sustained and of the magnitude needed to meet Peace Accord targets unless measures are also taken to address structural obstacles to economic growth. This, in turn, implies a resumption of reforms to address the most significant bottlenecks to growth in Guatemala.

Macroeconomic Concerns ix. The greatest macroeconomic challenge for Guatemala lies in improving its internationally low public revenue to GDP ratio. The Peace Accords set a target of 12 percent of GDP to be reached by 2002, a significant increase from the level that existed at the time of the Accords (7.9 percent). Unfortunately, progress has been slower than expected and the dearth of public funds continues to limit investments in key growth- enhancing investments, including those that are critical to boost the pace of economic and social progress. Moreover, with a relatively low level of tax receipts, fiscal policy has few degrees of freedom to accommodate shocks and provide countercyclical stimulus when needed.

X. Another subject of concern is the debate about the rising trend in the real exchange rate. The appreciation ofrecent years seems to stem mostly out of market forces, such as the large surge in remittances and capital inflows ofrecent years, making monetary policies unlikely to be effective in reversing the trend. In addition, these trends have not affected exports as strongly as it may seem, as witnessed by the 15% increase in the value of exports of 2004. To improve the competitiveness of Guatemalan exports, it may be more productive to focus energies on microeconomic reforms that may allow a better use of the opportunities of the increased access to international markets that will result from the upcoming CAFTA and other trade agreements. xi. Given the disappointing performance of the economy since the signing of the Peace Accords, the key issue remains how to achieve higher growth rates in the fbture and how to prioritize efforts, given the large amount of potential areas of action. This question is the focus ofthe remainder of the CEM.

c. PRIORITIES FOR FUTUREGROWTH xii. To deal with the challenge of identifying the factors that could most contribute to increase the rate of economic growth in Guatemala in the coming years, the CEM obtains some insights from a simple growth accounting exercise and then exploits a recent cross- country econometric growth model in order to prioritize reform areas.

Growth Accounting ... xiii. Growth accounting results reveal that the growth of labor, first, and capital, second, explain the bulk ofthe growth ofGDP for most ofthe last four decades. However, the changes in output growth over different decades are mostly due to changes in total factor productivity growth (TFPG) and to swings in the (declining) contribution of capital after the 1970s. While Guatemala has followed broadly the swings in growth ofthe rest of iv

Latin America, its distinguishing trait has been an above average labor contribution, mainly due to the surge in labor use in the 1990s. By contrast, the contribution ofcapital to growth has been lower than the regional average. xiv. The growth accounting exercise suggests that explanations for Guatemala’s poor growth performance are related to low TFPG as well as a disappointing pace of capital accumulation. In regional comparisons, Guatemala’s low rate of TFPG is the key difference with economies with the best growth performance in Central America during the 1990s such as Costa Rica and Panama and other LAC countries like the Dominican Republic and Chile. The prominent role played by a low level of TFPG in the evolution of overall growth of Guatemala suggests a number of possible factors that may be impeding growth: factor reallocation processes may not be functioning appropriately, the economic policy framework may not be guiding resource allocation decisions properly, the pace of adoption of improved technologies has been insufficient, or the quality of factors has not improved significantly through time. All of these potential problems highlight the need for public policy to spur productivity growth in Guatemala.

Determinants of Long Term Growth xv . The CEM uses the findings ofa large cross-country growth model --which relates economic growth to twelve key explanatory variables for 78 countries-- to analyze the determinants of past growth trends in Guatemala and to prioritize future areas of attention. The model, which tracks well developments in the 1980s and 1990s in Guatemala, disaggregates determinants of growth into five indicators related to structural policies and institutional development (comprising education attainment levels, financial depth, trade openness, government consumption and public infrastructure), four indicators related to macroeconomic policy outcomes (comprising measures of price stability, output volatility, real exchange rate over-valuation and the prevalence of systemic banking crises), and three exogenous variables (including the terms oftrade and period specific-shifts). xvi. The model can be used to predict the future level of growth in individual countries on the basis of forecasts of the future values of the explanatory variables. In making these forecasts, two scenarios have been considered. The first (“passive”) scenario assumes that the explanatory variables continue to evolve over the next decade according to past historical trends. The second (“active”) scenario assumes the implementation of policy reforms that raise all the explanatory variables to the top 25th percentile of their distribution in Latin America and the Caribbean. xvii. Under the first scenario, Guatemala’s growth would improve slightly, from 1.43 percent per annum in the 1990s to 2.2 percent on average for the 2000-2010 period. This rate would be just below the rate needed to meet the Millennium Development Goal of cutting extreme poverty by half by 2015, taking 2000 as the base year. Under the second “active” scenario, Guatemala would be able to boost its growth rate significantly by accelerating the pace ofkey reforms. Under this scenario, Guatemala’s average annual per capita GDP growth would increase to 5.04 percent in the 2000-10 period. If this rate were sustained, it would mean that extreme poverty would be reduced by more than half V between 2000 and 2015 (over 10 percentage points), and poverty would decline to about 31 percent. xviii. Most of the growth increase in Guatemala under the second scenario would emerge from the expansions of education and public infrastructure. The improvement in education policies explains a boost in annual per capita growth of 1.67 percent per year, while those in public infrastructure yield a 1.09 percent improvement. In third and fourth place, with somewhat less potential impact, are the impact of greater financial depth (0.49 percent) and trade openness (0.36 percent). xix. Since attempts to address all pending areas of reform simultaneously would disperse efforts and weaken results, the results ofthe exercise indicate those areas in which the highest yielding growth payoffs lie. The methodology indicates that the greatest impact on growth would materialize over the next decade if efforts are focused on improving human capital, infrastructure, financial development, and trade, areas in which Guatemala has been lagging significantly behind in its development vis-a-vis other Latin American countries and the rest ofthe world. In addition, governance and innovation policies are two hrther areas in which Guatemala has performed poorly and in which improvements toward regional or global standards could have a potentially large growth payoff.

Growth, poverty and inequality xx. While this CEM is focused on raising growth because this is likely to be the critical driver of poverty reduction in Guatemala over the coming years, it recognizes that the impact of growth on the poor is diminished by high inequality levels. Hence, it stresses the need for the growth policy agenda to pay special attention to measures that improve the growth-poverty payoff and to ensure that future development benefits all segments of society. Such an agenda should include maintaining macroeconomic stability, preventing financial sector crises, and financing a distributionally progressive public spending agenda, with emphasis on investments in human capital investments and in rural infrastructure that facilitate access ofthe poor to the fruits ofgrowth.

D. THE ROLEOF HUMANCAPITAL mi. A large body of microeconomic and macroeconomic evidence - from Guatemala and elsewhere - shows strong links between human capital development, human productivity, and economic growth. The evidence for Guatemala indicates that higher levels of schooling, increased training and capacity along with better health and nutrition would be the most effective measures Guatemala could take to enhance its growth potential in the long run. Future growth performance would also benefit from reducing the large existing inequalities in access to human capital in the country. xxii. Guatemala has some of the lowest indicators in these areas among the Latin American countries. While progress has been made recently, the net enrollment rates in primary education are below 90 percent, and in basic secondary school below 30 percent. Completion rates are extremely low, less than 40 percent in primary school, and repetition rates are high. The average years of schooling is the lowest in Central America at 3.5 vi years. The quality of education is rather low according to standardized tests and the level of inequality in access to education is extremely skewed (less than 10 percent ofthe lowest quintile completes primary school). The conditions are even more worrisome with respect to levels of malnutrition, where the country’s indicators are among the worst in Latin America, a factor that significantly reduces the ability to learn and develop as a productive individual. xxiii. Given the low levels of human capital, the returns both to individuals and society of higher levels of schooling are quite high. On average an additional year of schooling raises hourly wages by 6 percent. Female graduates of secondary schools earn 54 percent more than those with no education, and 37 percent more than those with primary education. It is important to note that these are private and not social returns to education, which a priori should be even higher. xxiv. Research for this CEM shows that increases in education were the main driving force behind total factor productivity growth during the last thirty years. Quality adjusted labor input explains 78 percent of GDP growth for the period. The impact of education on productivity comes through several main pathways: (a) through direct improvements in worker productivity; (b) through increased ability of workers and enterprise managers to make appropriate decisions about the most efficient mix of inputs and technologies in production; (c) through an increased ability to adapt to changing technologies, policies, and the external economic environment; and (d) at high enough levels of education, through an ability to generate new, productivity enhancing innovations. Studies show that productivity improvements occur only after students achieve a certain level of finctional and numeracy, or have the cognitive skills to make complex decisions. xxv. The estimates of the impact of education on economic growth for Guatemala are sizeable. Calculations for this study show that a one percentage point increase in the average years of schooling would raise GDP growth by 0.33 percent. If the country could raise the level of gross enrollment to levels comparable to Latin American leaders, the average growth rate per capita over the next ten years could rise by as much as 1.6 percent per annum. xxvi. Besides the level of education, the health status of individuals is also critical for their ability to be productive. Microeconomic evidence from Guatemala and elsewhere shows that stunting (or low height for age) - an indicator of chronic malnutrition -- negatively affects people’s ability to learn, and their ability to carry out physical work and to earn as adults. In rural Guatemala, analysis of longitudinal data indicates that stunting reduces children’s intellectual functioning, leading to poorer performance on tests. Recent studies have shown that improved nutrition accounts for an appreciable share of income growth and has a significant impact on economic growth. These results support the view that to be filly effective human capital policies to promote growth in Guatemala should focus on health - and specifically chronic malnutrition - as well as on education. xxvii. The key measures required to improve the level ofhuman capital thus include: vii

0 completing the unfinished primary education agenda, with emphasis on raising primary school quality, retention, and completion rates; 0 strengthening Guatemalan’s productive capacity through improving the nutritional status ofthe population; and 0 achieving greater access to and participation in secondary education, to position Guatemala to take full advantage ofemerging economic opportunities. xxviii. Key actions to complete the unfinished primary education agenda include:

0 Continuing to expand access to primary education, particularly through the PRONADE program; 0 Improving school quality to raise cognitive achievement, increase education efficiency, retention and completion levels; This requires o bilingual learning materials, bilingual education, multi-grade teaching where appropriate, and ongoing student assessment; o improved teacher training and education through development of teachers’ guides, in-service training in classroom management, training ofteachers in developing a supportive environment for education for girls and indigenous children; o improved school quality through institute measures to increase community participation and school-based management. xxix. In secondary education the key is to expand access and participation. Measures should consider:

0 Addressing both demand and supply constraints to secondary school access and participation. Analysis indicates that while demand side factors - such as the costs of secondary schooling - are the key constraint to greater enrollments in urban areas, supply factors - such as the lack of school facilities - and demand factors are both key constraints to enrollment in rural areas; 0 Fostering private and NGO, as well as public sector, participation in the delivery of education services. In contrast to primary education, which in public sector provision predominates, about 55 percent of secondary students enrolled in private schools and another 10 percent in Cooperative schools in 2000. 0 Adopting alternative approaches to expanding secondary schooling opportunities to ensure greatest outreach, particularly in rural areas. This could include, for example, the expansion of the NEU multi-grade model to encompass nine grades, as well as extension of secondary-level distance learning opportunities (telesecunduria) xxx. To address malnutrition, it is necessary to adopt a multi-sectoral approach that deals with nutritional, health, and environmental conditions and promotes behavioral changes. The recommendations are to: viii

Improve prenatal nutrition through counseling on dietary intake and weight gain during pregnancy, and iron and folic acid supplementation provided to pregnant women;

Strengthen mothers’ infant feeding practices and care behaviors, through information on breastfeeding and complementary feeding, as well as environmental health promotion activities, such as hand washing and training in hygienic water handling practices;

Reduce environmental risks for common childhood illnesses through improved access to potable water and sanitation, as well as reduction of indoor air pollution from cooking fires;

0 Increase access to quality family planning services through increased provision of and access to culturally appropriate information and counseling, as well as a wide choice of family planning methods;

Strengthen and improve monitoring of food fortification programs countrywide (Le., fortification of staples with vitamin A, iron, and iodized salt).

Improve access to and use of preventative and curative health services including increased child immunization, growth monitoring, de-worming, and better control ofinfectious diseases and common childhood illnesses. xxxi. The measures in education and health will require additional public and private resources, as Guatemala ranks poorly among Latin American countries social sector spending. Conservative estimates indicate that a program to achieve universal basic education with the types of quality improvements necessary to maximize the growth impacts of additional education would require a 44 to 48 percent increase in the education budget. Since this may be overly ambitious in the short-run, the government might consider a phasing in of spending increases over time, beginning with a goal of achieving the roughly 8.3 percent real increase in annual education sector spending necessary to achieve universal primary education. Additional incremental increases could then be made over time - toward the 44-48 percent benchmark - to ensure that both education access/coverage and education quality issues are adequately and appropriately addressed. With respect to confronting chronic malnutrition, financing needs are also significant. Fully funding a package of required services would require approximately a permanent increase of 7.4 to 12.8 percent in total public spending on health in Guatemala. xxxii. Clearly, tackling the growth agenda through these investments will take considerable additional resources and efforts to strengthen service delivery in the education and health sectors. But the long-term pay-offs of these additional investments will also be large. ix

E. IMPROVING THE INVESTMENT CLIMATE Governance xxxiii. Guatemala ranks very low among countries in the areas of governance, the rule of law, institutional capacity, government effectiveness, control of corruption and voice and accountability. In a recent survey of entrepreneurs, the major obstacles to a good business climate were the level of corruption (where Guatemala ranks 100 out of 130 countries), crime and violence and regulatory policy uncertainty. Moreover, one of the reasons for the lackluster performance of the economy in the last few years has been a deteriorating business climate. Increasing levels of violence and crime, corruption and a confrontational attitude of the Government towards the private sector in the last four years discouraged many enterprise activities. xxxiv. Guatemala will need to make concerted efforts in order to overcome those factors that are adversely affecting the business climate. Corruption is endemic in many areas of society and requires concerted efforts in the part of the government and civil society to combat its causes. A comprehensive approach to deal with the corruption should include:

0 transparency in expenditures and government procurement;

0 a civil service reform; 0 the approval of the probity law;

0 greater and more prompt enforcement of existing laws on bribery and misallocation of funds; and 0 support for a survey on the sources and causes of corruption, along with the development ofa plan ofaction. xxxv. In the area of crime and violence, it will be essential to:

0 provide the police, the office of the prosecutor and the judicial system with adequate resources to increase the number of officers, and the ability to investigate and prosecute criminals; 0 improve the coordination of criminal investigations between the Office of the Prosecutor and the PNC. xxxvi. As noted, the regulatory burden, the weak regulatory quality, and in particular the discretionary use ofregulatory powers are some ofthe major sources of discouragement to investment. There is a pressing need to:

0 review the regulatory structure in the country; 0 simplify regulations and clarify rules for dealing with customs, tax administration, and labor matters; 0 streamline the investment approval process: 0 strengthen the current efforts under the Agency for the Promotion of Investment and the National Program for Competitiveness, particularly in the areas of organization ofproducers, quality standards, and certification; 0 make effective the operation ofthe consumer protection agency. X

xxxvii. A critical area for the improvement of the business climate is the modernization of the judicial system. Despite efforts to modernize the system since the signing of the Peace Accords, there are still considerable inefficiencies and delays that adversely affect the investment climate. The systems of property rights and contract enforcement are still weak, and dispute resolution settlement imposes a high cost of doing business. The abusive use ofthe appeal is a particular concern. The main measures in this area should involve:

continue the process ofmodernization ofthe judicial system; 0 limit the appeal process currently in place and ensure cases are resolved within a reasonable period oftime; 0 enhance the system of property rights, particularly by improving the management ofthe Registry of Properties; 0 develop the alternative dispute resolution system for commercial cases; 0 improve resources for judicial system, and the efficiency ofits management; 0 provide training to judges on commercial law.

Infrastructure xxxviii. The country’s infrastructure endowment historically has been very poor and has limited the country’s growth potential. Infrastructure improvement would be critical for raising the levels of productivity and growth. This report estimates that perhaps as much as one percentage point could be added to the trend growth rate if the country’s infrastructure standards could be brought to the highest levels of Latin America. xxxix. The restricting role of infrastructure in the country’s growth potential is best exemplified by the state of its transport structure. In the last ten years the length of the road network, for example, has increased by only 19 percent, even though considerable progress took place in the mid nineties. The country’s classified road network is approximately 14,000 km (the non classified amounts to another 12,000 km). Only about 4,000 km are main and secondary roads. This translates into 1.2 km per 1,000 people, one of the lowest in the region. Close to 13 percent of the households simply lack access to a passable motor road. These populations are constrained and confront high, if not un- surmountable, costs to access markets and other services. The structure of the road network, which is even more deficient in the rural and medium size cities, also has contributed to the high concentration ofthe population in the capital city. xl. The ports system in Guatemala suffers mostly from inefficiency than simply throughput capacity. The system is a mix of private and public sector participation, with one port (Barrios) being essentially private but with limited capacity, while the Pacific coast port (Quetzal) is managed through a system of concessions, and the less efficient port (San Tomas) is government run and handles most ofthe cargo in the Atlantic. The latter is starting to face strong competition from ports in neighboring countries, a development that clearly indicates the eventual need for a regional integration of services. One critical service for the efficient handling of external trade is customs administration. While there has been improvement in this area, with the creation of the Superintendence of Tax xi

Administration (SAT) and the introduction of modern equipment, the system is still quite inefficient, with cargo waiting on average five days, which is more than in other countries ofthe region. xli. There has been significant improvement in many infrastructure areas over the last few years. Two important sectors (telecommunications and electricity) have expanded significantly since they were partially privatized and deregulated in the mid nineties. The removal ofthe state monopoly position in telecommunications in 1996, and the subsequent of the telephone company led to unprecedented growth of coverage. The number of fixed lines, for example, has more than tripled from 286,000 in 1994 to 750,000 in 2001 years. The number of lines per 100 persons is now 6.5. The growth in cellular telephony has been even more impressive. In 1995, there were only about 30,000 cellular phones in the country, by 2002 the number had jumped to 1.14 million. Similarly, the number of companies operating in the country has increased (to 21), and the price as well as the time for both installation and calls has declined dramatically. Deficiencies still remain in the rural telephony, where coverage is very low and the state still supports the main program of extension of coverage, and in the supervisory capacity, which has been hamstrung by lack ofbudget, better technical capacity and stronger regulatory powers. xlii. There has been significant progress in electricity coverage since the reforms were introduced in the mid nineties. Since then, Guatemala has made significant and fast progress in electricity coverage. Installed capacity has been increasing steadily from 1,3 14 MW in 1996 to 1,670 MW in 2002, equivalent to a 27 percent raise. Improvements in efficiency and the implementation of a rural electrification program have resulted in a significant increase in electricity coverage from 53 percent in 1996 to 85 percent of households connected in 2002 (the second highest level in Central America after Costa Rica). Service has also improved. xliii. The critical issue in electricity now is the tariff levels. With the privatization of distribution and with the deregulation of producers, cost recovery principles apply to tariff setting. Large consumers can now buy electricity directly from producers at negotiated prices. Very small consumers are subsidized. In fact, the law until recently established a low social rate for consumption below 300 kwh per month. The limit was rather high and covered 90 percent of the households and 43 percent of energy distributed. The government lowered the threshold to 100 kwh, a measure that is confronting high resistance. As a result of the skewed tariffs, medium size electricity consumers, primarily small and medium size enterprises, pay fairly high tariffs (between 25 to 70 percent more than any other Central American country). This is hurting their competitive position. xliv. The coverage and quality ofthe country’s infrastructure differs considerably. The benefits to investment in infrastructure are particularly high in the rural areas, where coverage rates are fairly low. With 61 percent ofthe population residing in rural areas and 75 percent of rural inhabitants living in poverty, improving the livelihoods of rural is key to the growth and future ofthe country as a whole. Large inequities in urban-rural infrastructure service coverage exist. While piped water and electricity are almost universal in urban areas, they reach little more than half of rural households. An xii estimated 30-40 percent of the rural population has no water service and more than 50 percent have no improved sanitation facility. xlv. These coverage figures fail to show the limited quality of existing services; most of the rural water systems do not deliver potable water, have very weak management structures and lack appropriate tariffs. Many households in rural areas are without year- round access to roads or public transport, further exacerbating their isolation and lack of opportunities. It is estimated that rural roads that give access to markets by producers have rates of return of close to 15 percent. In the last few years, budgetary restrictions have led to decline in investment in infrastructure, and its quality has visibly deteriorated. Less than one third of rural roads receive rehabilitation or routine maintenance in a given year. Electricity service in rural areas is usually single-phase, limiting opportunities to use productive equipment such as motors or mills. While 80 percent of rural communities are within 6 km of a community payphone, only 6 percent of rural households have fixed or mobile phones. xlvi. The main challenges confronting the authorities in the infrastructure sector are:

0 to extend the coverage in the rural areas; to modernize and improve the efficiency ofmany sectors; to increase the participation ofprivate investors and managers in some of the sectors; and to review tariff issues and strengthen the regulatory structure. xlvii. This Country Economic Memorandum (CEM) analyzes the prospects and policies Many ofthe sectors in infrastructure still confront standard issues of coverage and poor quality. This is particularly the case in those sectors that have not gone through important processes of modernization and reform, such as transport, including ports and customs, and water and sanitation. The policy recommendations for the specific sectors are described below. xlviii. In the telecommunications sector, progress so far achieved could be sustained and improved by initiatives in the following areas:

0 improve regulatory governance and power of regulatory agency, specially to oversee anti-competitive strategy by dominant firms; and improve mechanisms for private participation in rural telephone infrastructure. xlix. In the electricity sector, policy actions in the next few years should:

0 preserve the current definition of the social tariff, and provide subsidies exclusively the most economically vulnerable portion ofthe population; 0 fine-tuning the regulatory framework, specially to provide incentives for long term investment and efficient energy use; 0 promote aggressively the implementation the Rural Electrification Program and decide on financing mechanisms to allow for on- and off-grid solutions to provide electricity to the remaining households without electricity; and ... Xlll

0 devise mechanisms to increase access to productive uses and micro-finance services so as to allow customers to generate income through the use of infrastructure services such as electricity.

1. In the transport sector, access is a key issue, as the country is predominantly rural. In this sense, it will be necessary to:

extend coverage selectively within strategy aiming at strengthening rural-urban linkages and developing trade corridors; 0 reduce regulatory risk to allow private sector participation in construction, operation and maintenance 0 implement suitable regulatory framework (through the approval of the concession law) and introduce the institutional capacity (independent concession unit) to attract private participants. li . Another issue is the impact of fiscal adjustment on resources for road maintenance:

minimum maintenance levels should be kept to avoid excessive deterioration and associated higher recovery expenditures; 0 one alternative would be to secure funding for COVIAL and making it an autonomous institution to avoid political interference; planning capacity at both central and local levels should be strengthened. lii. In the port sector, policy should involve, among others, the following priorities:

0 reduce political interference in publicly administrated ports through improving user’s participation in the executive boards; 0 introduce financial discipline; and modernizing management process in public ports with due attention paid to human resource management, productivity and transparency (if privatization is not feasible); take measures, through the elimination of current roadblocks, to reduce the time required to load - unload and release cargo from the ports; and 0 implement regulatory and institutional reforms to facilitate private participation, perhaps starting with port extension (e.g. in Puerto Quetzal due to a saturation problem). liii. Customs reform should focus on two main priorities:

0 implement a custom reform strategy to improve trade facilitation, possibly through the implementation ofthe Central America customs union; and 0 reinforce the credibility of customs by finalizing the modernization process, intensifying training, and implementing quality-based management. liv. In the water and sanitation sector, there are several measures that could improve coverage and quality of services. The most important are: xiv

to reform the legal and institutional framework in order to clarify the roles of different government institutions; obtain approval of the Water Bill under discussion, which seems to be well designed (it defines the Instituto Nacional de Agua Potable y Saneamiento, as the policy maker, the Comisi6n Nacional del Agua Potable, as the regulatory body and relies on public, private or public-private suppliers for the provision of services); reduce uncertainty by assigning the responsibility to the Comisi6n Nacional de Agua Potable to allocate the concessions. This will increase transparency in the sector, and will clarify the role of private involvement. This issue is more relevant in urban and industrial areas where potential economic growth is larger, than in rural zones. Increase public funding to improve the access to water and sanitation systems in the rural areas, financing projects under Modelo Basico, which has proven to the most appropriate course ofaction.

Financial Development lv. There is strong evidence of a causal link between financial depth and soundness and economic growth. Financial markets influence economic efficiency and economic growth through different channels, helping with the mobilization of savings and with the identification of profitable investment projects. In Guatemala improvements in the coverage of the financial sector to levels comparable to Latin American leaders could add one half ofa percentage point to the growth rate per annum over the next ten years. lvi. Although there has been progress made over the recent years in the process of financial sector reforms, Guatemala still shows low levels of financial depth. With the volume of credit to the private sector reaching only about 22 percent of GDP, Guatemala’s financial system is underdeveloped by global standards.

lvii. The financial system is dominated mostly by private banks operating at the center of financial conglomerates, which also often includes warehouses, insurance companies, and “bonding” companies. The banks account for almost 91 percent of the regulated system’s assets. Most of all of the large and medium-size private banks are said to have a related offshore bank as part of the group, and most of the large financial conglomerates are embedded into broader economic, family-dominated groups. The public sector has only a small participation in the financial sector, but the public banks confront special challenges. There is a relative large unregulated system, comprising mostly of leasing, factoring, and credit card companies.

lviii. The Guatemalan financial system is sound in general terms and is poised for a process of modernization. A recent set of reforms, particularly through the approval of important new legislation has set up the conditions for a more solid expansion and consolidation. The new laws improved bank licensing provisions; consolidated supervision and regulation of financial groups, including off-shore banking; strengthened the regulatory framework and prudential rules; enhanced governance and transparency of banking institutions; and limited the deposit insurance system. It also reiterated the Central xv

Bank independence, defined its roles, and ensured the measures of capital markets liberalization that had taken place earlier through executive decrees. lix. As a result of the laws, several measures have been taken, such as improvements in consolidated supervision, the formation of consolidated financial groups, and the creation of a trust fund to assist with mergers and acquisitions. There is, however, considerably more that needs to be done, such as:

0 onsite inspection ofthe offshore banks; 0 the licensing ofa number of financial conglomerates and offshore banks; 0 make the bank resolution framework operational. with respect to the latter, there is a need to approve legislation to exempt from valued added taxation financial transactions associated with mergers or acquisitions; 0 other legislation that is pending and important to complete the reforms includes those related to non-bank financial intermediaries and secured transactions. lx. One of the biggest challenges in the financial sector, however, is to increase coverage in rural areas, and improve the use of collateral, particularly by rural population. lxi. Only 13 percent of the rural households applied and received any kind of a loan according to a 2000 survey (just 10 percent of landless households applied and received a loan as opposed to 15percent for landowner households). The poor have little access to titled land that could serve as collateral, preventing households from obtaining credit for input purchases or diversifying their economic activities. Only a third of the poor have land titles, compared to almost half of the non-poor. Lack of collateral is one of the most frequent reasons households refer to for not applying for a loan. The banks of the system have most of their operations concentrated in the urban areas. Only a few have national coverage and presence in the rural areas. The country counts with a vibrant micro-finance industry, but its coverage is still rather limited (with less than 100,000 clients.) The network ofcredit unions covers another 450,000 clients. lxii. The most important presence in the rural areas belongs to Banrural, a public- private mixed ownership bank. The institution has grown rapidly, from 90 branches in 2000 to over 250 by late 2003. While its mission statement identifies its primary objective to lend to micro, small and medium sized businesses, only 26 percent ofthe total assets are currently devoted to them. Most of the rest of the assets are in short and medium term investment instruments. lxiii. Other measures that could assist considerably with the expansion of rural finance involves:

0 the approval by Congress of the draft laws on the Cadastre and Property Registration, and on Secured Transactions, along with an acceleration of the cadastre program and the modernization ofthe Registry; xvi

0 additionally, the micro-finance market could benefit from a more transparent system and be transformed from unsupervised micro-credit to supervised micro-finance institution status.

F. TECHNOLOGYAND INNOVATION lxiv. All of the measures discussed above in distinct ways contribute to growth, many through their impact on productivity. As noted, the key to increasing per capita growth rates over time is to raise total factor productivity. Two of the most important driving forces of productivity are the introduction of new technology and the process of innovation. These two factors are often not discussed within the framework of economic growth in Guatemala. In fact, Guatemala is just now beginning to focus on the importance oftechnology and innovation in the context ofthe country’s hture development. lxv. There are several factors limiting technology and innovation in Guatemala. The national system of innovation, through the networks of science and technology centers is rather limited. The low level of international integration restricts the ability of firms to obtain technology through imported capital and or through suppliers. The overall the amount spent on direct technology accounted for less than 2 percent of sales of firms. And the skills base and the ability oflabor to absorb technology are somewhat low. lxvi. The main problems identified by firms as impediments to the purchase ofthe new technology were government regulation and taxation, lack of funding for acquisition of new technology, lack of qualified personnel to use new technology, and lack of opportunity to interact with similar companies. The latter is particularly limiting to small firms (52 percent); a factor that demonstrates the benefits that could be derived from measures to promote collaboration through incubators, technological parks, and clusters. Most of the financing for the purchase of new technology were internal, and small firms had little means to access bank financing. lxvii. There are several measures that could be contemplated to enhance the capacity of the country to induce technological innovation. Unquestionably, there is need to increase the skills level of the labor force. This, however, should be carried out mainly by private enterprises with limited participation of INTECAP covering only those looking for jobs. Another area where considerable returns could be obtained is to facilitate product upgrade through a better quality certification program. lxviii. The government might also focus CONCYT’s work to those programs that:

0 improve technological diffusion among small and medium size enterprises and expand the role ofthe private sector in an advisory board. lxix. The government might also wish to:

0 ease the import limitations that may exist on the purchase of machinery and equipment; xvii

0 adjust its foreign direct investment policy to attract more technology intensive FDI; strengthen the governance of technology policy, by defining an explicit technology and innovation policy, by enhancing the policy making role of SENACYT, and by simplifying the concessions of public funds for research and development.

G. TAKING ADVANTAGEOF TRADEOPPORTUNITIES lxx. The analysis prepared for the CEM corroborates that trade expansion plays a critical role in stimulating growth and poverty reduction. An open trade and investment regime encourages integration into the global trading environment and the import of diverse and modern technologies that are important for productivity improvements. For Guatemala, trade expansion is critical because it allows the economy to overcome the limitations in specialization and productivity growth imposed by a reduced domestic market. lxxi. Guatemala has made some progress in terms of trade openness in the 1990s. Trade flows (exports plus imports as percentage of GDP) increased by 11 percentage points between 1991 and 2001. However, most of this progress can only be attributed to import growth as total exports have remained practically stagnant for the last ten years at around 19 percent of GDP, despite positive developments in exports of maquila and other nontraditional products. lxxii. The stagnant export ratio of recent years is the result of significant differences in the dynamics of three different sectors. The first is the maquila sector, which has shown impressive growth since 1990, with net exports increasing steadily as a result of US trade preferences and the success ofthe free trade zone regimes in attracting FDI. The second is the group oftraditional export products (i.e., , , sugar and cardamom) which have seen trade volumes fall steadily during the 1990s, as a consequence of slow demand growth and low commodity prices. The third is nontraditional exports (e.g., flowers, seasonal vegetables, fruits, and organic crops), which grew dynamically until 2000 but have stagnated since, due to lower growth in the international economy. Despite these mixed trends, rapid growth of non traditional exports in recent years has made Guatemala into one ofthe most diversified exporters in Central America. lxxiii. The stagnation of export flows since 1990 and the sub-par economic growth record ofthe past few years suggest that the potential for trade in the Guatemalan economy has yet to be fully exploited. Even the dynamic maquila sector, which relies greatly on imported inputs, has not developed strong linkages with the rest of the economy. A key challenge for the hture is to boost and diversify trade in order to improve economic growth and poverty alleviation. lxxiv. The mediocre export performance of the last decade cannot be attributed to trade policies, as substantial progress has been made since the late 1980s in reducing tariff rates, eliminating most non-tariff barriers (NTBs), removing export licenses and , and xviii removing domestic price and foreign exchange controls. These policies have been complemented with a more open foreign investment regime and flexible foreign exchange arrangements. On the import side, a few tariff peaks remain (in agriculture) but the use of non-tariff barriers is not significant, aside from the quotas associated with sensitive agricultural products. Preferential access to the U.S market has led to significant growth in maquila and non-traditional agricultural goods. The former has also benefited from incentives to investment granted by FTZ regimes. Clearly, the bottlenecks for a more robust aggregate response of trade to growing opportunities abroad lie outside of the narrow sphere oftrade policy. lxxv. Guatemala and the U.S. ended negotiations for CAFTA at the end of 2003. The treaty should enter into force after ratification by congresses, expected for late 2004 or early 2005. While Guatemala already enjoys an open trade stance, CAFTA certainly offers new opportunities as well as challenges that could have a profound impact on its development prospects. CAFTA will widen the opportunities to boost exports, investment, growth and employment by granting expanded and more stable access to the biggest market economy in the world. In particular CAFTA will provide a broad framework for trade and investment relations between the US and the CA countries that will be substantially more comprehensive and far reaching than the current unilateral preferences under the CBI. lxxvi. CAFTA is a promising initiative for Guatemala to expand trade levels, boost investment and growth and reduce poverty. CAFTA is likely to enhance market access to some Guatemalan products, while making permanent the unilateral preferences offered in the past through CBI preferences. Additionally, the more comprehensive nature ofCAFTA is expected to ‘lock in’ broad reforms and send a strong signal to investors. lxxvii. Assuming that Guatemala can replicate only part of the experience of Mexico under NAFTA, where the increase in the trade openness index rose from 33.3 percent of GDP in 1994, to 53.1 percent 1995 and 63 percent in 2002, the increase in level of economic growth could be significant. With only half as much increase in trade openness, the trend per capita growth in Guatemala could rise by as much as 0.4 percent over the next decade. With regard to the impact on the more sensitive agricultural sector, the study finds that Guatemala exhibits comparative advantage in 26 1 product categories, which account for 80 percent of the agricultural exports. Many of these face barriers that would be removed over time. With respect to imports, the aggregate welfare impact might be positive since the country is a net consumer in those products that would be most affected, such as yellow corn, rice, , beef and poultry. The fiscal impact of the reductions in tariffs could amount to close to 0.5 percent of GDP and will require compensatory fiscal measures. lxxviii. CAFTA alone is not enough to generate the large investment and trade response required to lift trend growth as described. Lessons from the Mexican experience and others indicate that Guatemala needs to advance in key policy and investment areas to ensure that CAFTA’s potential for economic and social development can materialize. Actions needed to exploit the static and dynamic gains from this agreement coincide broadly with the agenda spelled out in this CEM to enhance growth. They are also the measures needed to xix remove the bottlenecks that have impeded a more robust growth oftrade in recent years. In order to optimize CAFTA’s trade and growth gains, key complementary policies should include:

improve education levels and boost the quality and productivity ofresearch efforts, 0 address deficiencies in infrastructure and customs efficiency, maintain sound macroeconomic management, strengthen institutional development and improved governance structures, ensure that disadvantaged Guatemalans do not suffer unduly during the transition and that MSEs are supported to share in the benefits ofgreater trade.

lxxix. Guatemala will also need to upgrade policies and regulations, which are currently inadequate or insufficient to conform to CAFTA requirements. These include:

improving transparency, competition, and non-discrimination in government procurement; removing many of the tariff and other exemptions on imported inputs for products that are exported; enforcing property rights; and improving labor and environmental standards.

GUATEMALA- CEM xx Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo

GUATEMALA MEMORANDOECON~MICO DEL PAiS Los DESAF~OSDE RESTAURARUN MAYOR CRECIMIENTO ECON~MICO

RESUMENEJECUTIVO

A. INTRODUCCI~N

i. La finalidad de este Memorando Economic0 del Pais (CEM, por sus siglas en ingles) es contribuir a1 dialog0 en Guatemala sobre 10s medios para acelerar el crecimiento economico, para ayudar asi a lograr 10s objetivos que se establecieron en 10s Acuerdos de Paz de 1996 y, en particular, a cumplir con uno de 10s ingredientes clave en la lucha contra la pobreza. Con respecto a1 ultimo punto, este documento complementa a otro estudio reciente del Banco Mundial (“La Pobreza en Guatemala”, Banco Mundial, 2002), que identifico la necesidad de un mayor crecimiento economic0 sostenido como uno de 10s elementos indispensables para la reduccion continua de la pobreza.

11. El CEM ofrece un diagnostic0 de las causas del estancamiento en el crecimiento de la economia durante la mayor parte de la decada anterior, en especial despues del aiio 2000, desde cuando el incremento en el ingreso per capita practicamente no ha variado sustancialmente, y presenta recomendaciones sobre las direcciones y prioridades de la politica para el corto y mediano plazo, enfocadas en ayudar a desencadenar el considerable potencial de la economia de Guatemala. El Capitulo Iexamina 10s desarrollos historicos y econdmicos recientes, y utiliza una metodologia de estudios comparativos de crecimiento para identificar las medidas y politicas m8s conducentes a la dinamizacion de la economia en el mediano plazo. Aquellas areas identificadas como criticas en la lista de prioridades se desarrollan con mas detalle en capitulos posteriores. El Capitulo I1 se enfoca en el importante papel que juega el desarrollo del capital humano en el crecimiento, junto con las politicas complementarias para mejorar la education y la salud. El Capitulo I11 examina en el “clima de inversiones” ampliamente entendido, dentro del cual se incluye las areas de gobernabilidad, acceso a infraestructura y desarrollo financiero. El Capitulo IV analiza la importancia de la innovation y la adaptacion de tecnologia para mejorar la productividad. El Capitulo V examina el grado de apertura a1 comercio exterior y a1 papel catalizador que el acuerdo de libre comercio con 10s Estados Unidos (CAFTA) podria tener en la economia guatemalteca.

B. CONTEXT0 DEL PAiS ... 111. Los desarrollos socioeconomicos de Guatemala por mucha de su historia moderna se han visto marcados por las tensiones sociales, las cuales han dejado marcas profundas en la estructura social asi como inseguridad, miedo y desconfianza. Est0 a su vez ha debilitado seriamente el capital social, ha obstaculizado la aparicion de instituciones transparentes y legitimas, y ha afectado negativamente a la gobernabilidad y el derecho de ley. En cuanto a1 impact0 economico a largo plazo del agudo conflict0 que finalizo en 1996 con 10s Acuerdos de Paz, quizas sus consecuencias mas grandes hayan sido el desplazamiento de mas de 1/12 de la poblacion del pais (mas de un millon de personas), GUATEMALA- CEM xxi Los Desafios de Restaurar un Mavor Crecimiento Emndmico Resumen Eiecutivo niveles de pobreza e desigualdad extremadamente altos, e inversiones bajas en el desarrollo humano, especialmente entre la poblacion rural e indigena. iv. Hoy en dia, a pesar de un ingreso per capita de $1,740, que coloca a1 pais entre 10s rangos de 10s paises de ingresos medios, Guatemala exhibe indicadores sociales bajos en relacion a 10s demas paises en la sub-region. Los logros educativos son extremadamente bajos (un promedio de 3.5 aiios de escolaridad), la matricula neta en escuela secundaria es de menos del 25 por ciento y el indice de analfabetismo continua siendo muy alto, por encima del 25 por ciento de la poblacion. Los indicadores de salud son igualmente pobres-con indices extremadamente altos de mortalidad maternal e infantil, altos niveles de desnutricion, y menos de dos tercios de la poblacion con acceso a servicios basicos de salud-, encontrandose entre 10s mas altos en el mundo.

V. En cuanto a las tendencias economicas generales, Guatemala ha seguido en terminos generales 10s patrones evidentes en el resto de Amkrica Latina, con una caida del crecimiento en 10s ochenta, a raiz tanto de las perturbaciones causadas por el conflict0 interno como por la cesacion de la fase inicial de sustitucion de importaciones. Con el regreso a la democracia a mediados de 10s ochenta, el pais comenz6 un periodo de reformas economicas, que involucro la liberalizacion del rkgimen de comercio exterior y de 10s mercados financieros en 10s ochenta y a principios de 10s noventa, respectivamente. Desde mediados de 10s noventa, las reformas se han enfocado en facilitar una mayor participacion del sector privado en la provision de servicios clave, como por ejemplo en 10s sectores de energia y telecomunicaciones. Aunque Guatemala solo experiment6 un progreso limitado en la expansion de su comercio exterior en 10s noventa, las cifras agregadas ocultan cambios importantes, ya que se produjo un aumento significativo en el sector de maquilas y de exportaciones no-tradicionales (tale como flores, vegetales de temporada, frutas y plantas organicas), el cual, aunado a1 declive de las exportaciones agricolas tradicionales, ha llevado a una diversificacion importante en las exportaciones. vi. La mayor diversificacion de la economia ha reducido la volatilidad economica (y en exportaciones) de Guatemala per0 no han resultado, hasta ahora, en tasas de alto crecimiento economico. Desde 1996, la economia guatemalteca ha crecido a un indice un tanto desalentador de 3.3 por ciento a1 aiio en promedio, muy por debajo de la meta de 10s Acuerdos de Paz de 6 por ciento en crecimiento anual. El crecimiento ha sido especialmente lento en 10s ultimos cuatro aiios, alcanzando tan so10 un 2 por ciento en el 2003 versus un crecimiento de la poblacion de 2.7 por ciento a1 aiio. Sin embargo, el declive resultante en el PIB per capita y el posible incremento en pobreza se ha visto amortiguado por un fuerte aumento en remesas del exterior, principalmente destinados a familias en el sector rural, que achian como una red de seguridad importante. El consumo agregado tambikn ha gozado de la amortiguacion de flujos de financiamiento externo a 10s sectores publico y privado, que se reflejan en deficits sustanciales en la cuenta corriente durante 10s ultimos afios. vii. La deceleracion economica evidente desde el aiio 2000 respondi6 tanto a factores externos como internos. En el ambito externo, 10s factores clave heron: el declive pronunciado en el precio del cafe y la disminucion en la demanda de exportaciones clave como resultado de la reduction de la economia de 10s Estados Unidos. En el ambito GUATEMALA - CEM xxii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo intemo, aunque las politicas macro-fiscales han sido generalmente solidas, las condiciones macroeconomicas inestables de 1998 a1 2000 restringieron la demanda agregada, mientras el intenso conflict0 entre la administracion anterior y segmentos del sector privado deterioraron la gobernabilidad y el clima de inversiones, con el consecuente desestimulo a las inversiones extranjeras y nacionales. Asimismo, Guatemala no logro persistir con el esfuerzo reformador de 10s ochenta, quedandose atras especialmente en la importante tarea de fortalecer sus instituciones publicas. ... viii. La disipacion gradual de 10s choques extemos negativos de 10s aiios recientes, encabezada por el aumento en la demanda de 10s Estados Unidos de importaciones guatemaltecas, es terreno fertil para que se genere una recuperacion paulatina del crecimiento, tal como lo indican la expansion de 2.7 por ciento en la economia durante el 2004. En el 2005 y 2006, el comportamiento de la economia debera mejorar con el robustecimiento de la demanda extema de sus socios comerciales (especialmente de 10s Estados Unidos), y con 10s efectos esperados en la inversion y en las exportaciones del tratado de libre comercio con 10s Estados Unidos (CAFTA), asi como con la profundizacion de 10s esfuerzos de integracion regional. La recuperacion tambiCn se vera impulsada por la mejora en el clima de negocios gracias a 10s esfuerzos del gobiemo del presidente Berger. No obstante, para que la mejoria economics sea sostenible y de la magnitud necesaria para cumplir con 10s objetivos del Acuerdo de Paz se requieren tambiCn medidas para resolver 10s obstaculos estructurales a1 crecimiento economic0 y un fortalecimiento del esfuerzo reformador.

Preocupaciones macroecon6micas ix. El reto macroeconomico mas grande para Guatemala yace en mejorar la recaudacibn fiscal como proporcion del PIB, la cual sigue siendo baja de acuerdo con parametros intemacionales. Los Acuerdos de Paz establecieron una meta de 12 por ciento del PIB para el 2002, aumento significativo con respecto a1 nivel que existia en aquel tiempo (7.9 por ciento del PIB). Lamentablemente, no ha sido facil avanzar tan rapido como se desearia en este frente, por lo cual la escasez de recursos publicos sigue limitando inversiones clave para fomentar el crecimiento, incluyendo aqukllas que son criticas para acelerar el paso del progreso economico y social. Asimismo, con un nivel relativamente bajo de recaudacion, la politica fiscal tiene pocos grados de libertad para responder ante choques inesperados y proveer estimulos contra-ciclicos cuando fuera necesario.

X. Otro tema de preocupacion ha sido el debate en tomo a 10s niveles de la tasa de cambio real. La apreciacion de 10s ~ltimosaiios parece estar impulsada en gran medida por fuerzas del mercado, tales como el creciente flujo de remesas asi como la entrada de flujos de capitales, por lo cual no es probable que la politica monetaria pueda revertirla facilmente. Ademas, no parece haber afectado sustancialmente el comportamiento de las exportaciones, las cuales aumentaron en un 15 por ciento en el 2004. Para mejorar la competitividad de las exportaciones, es recomendable concentrar las energias en las reformas microeconomicas que permitan el mejor aprovechamiento del mayor acceso a 10s mercados intemacionales que va a proporcionar el CAFTA y 10s demas acuerdos comerciales en negociacion. GUATEMALA - CEhf xxiii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo xi. Debido a1 desempeiio desalentador de la economia desde que se firmaron 10s Acuerdos de Paz, el tema clave sigue siendo cdmo lograr tasas de crecimiento mas altas en el fbturo y c6mo establecer prioridades dentro de la gran cantidad de areas potenciales de accion. El resto de este informe contribuye con algunas respuestas a esta pregunta.

c. PRIORIDADES PARA EL CRECIMIENTO DE GUATEMALA xii. Para enfrentar 10s retos de identificar 10s factores que podrian contribuir mas a1 aumento del indice de crecimiento economic0 de Guatemala en 10s proximos aiios, este estudio usa un ejercicio simple de descomposicidn contable del crecimiento y aprovecha un modelo de crecimiento economktrico reciente con datos de una muestra amplia de paises, para establecer prioridades en las areas de reforma.

Contabilidad del crecimiento ... xiii. Los resultados de analisis de descomposicih contable del crecimiento revelan que el crecimiento de la mano de obra, en primer lugar, y de capital, en segundo, explican la mayor parte del crecimiento del PIB para la mayor parte de las cuatro 6ltimas decadas. Sin embargo, las variaciones en el product0 durante las diferentes dkcadas son principalmente a causa de 10s cambios en el crecimiento de la productividad total de 10s factores (TFPG, por sus siglas en inglks) y a las variaciones en la contribucih (en declive) de capital despues de 10s 1970s. Aunque Guatemala ha seguido en general las variaciones de crecimiento del resto de America Latina, su marca de distincih ha sido una contribucion de mano de obra por encima del promedio, principalmente gracias a la resurgencia del us0 de mano obra en 10s noventas. Como contraste, la contribucion de capital a1 crecimiento ha sido mas baja que el promedio regional. xiv. El ejercicio de analisis de crecimiento implica que el desempeiio deficiente del crecimiento de Guatemala esta relacionado con un TFPG bajo, ademas de un ritmo desalentador de acumulacibn de capital. En comparaciones regionales, el bajo indice de TFPG de Guatemala es la diferencia clave con las economias con el mejor desempeiio de crecimiento en America Central durante 10s noventas, tales como Costa Rica y Panama, y otros paises latinoamericanos como la Republica Dominicana y Chile. El importante papel que ha jugado un nivel bajo de TFPG en la evolucion del crecimiento general de Guatemala revela varios factores posibles podrian estar impidiendo el crecimiento: 10s mecanismos de asignacih de factores podrian estar hncionando inadecuadamente, el marco de politicas econdmicas podria no estar guiando las decisiones de distribucion de recursos a su mejor uso, el ritmo de adopcibn de mejores tecnologias ha sido insuficiente o la calidad de 10s factores no ha mejorado considerablemente a traves del tiempo. Todos estos problemas potenciales recalcan la necesidad de una politica publica explicita dedicada a estimular el crecimiento de la productividad en Guatemala.

Determinantes del crecimiento a largo plazo xv. El CEM usa 10s resultados de un modelo de crecimiento con datos de una muestra de 78 paises, que relaciona el crecimiento economic0 con doce variables explicativas clave, para analizar 10s determinantes de las tendencias pasadas de crecimiento en GUATEMALA - CEM xxiv Los Desafios de Restaurar un Mavor Creeimiento Eeondmieo Resumen Eieeutivo

Guatemala y el establecimiento de prioridades en areas futuras de atencion. El modelo, que examina 10s desarrollos en 10s ochenta y noventa en Guatemala, desglosa 10s determinantes de crecimiento en cinco indicadores relacionados con politicas estmcturales y desarrollo institucional (incluyendo niveles de logros educativos, profbndidad financiera, apertura comercial, consumo gubernamental e infraestructura publica), cuatro indicadores relacionados a 10s resultados de politica macroeconomics (incluyendo medidas de estabilidad de precios, volatilidad de produccion, sobrevaluacion de la tasa de cambio real y la existencia de crisis bancarias sistemicas), y tres variables exogenas (incluyendo 10s terminos de intercambio comerciales).

xvi. El modelo se puede usar para predecir el nivel de crecimiento futuro en cada pais basandose en pronosticos de 10s valores futuros de variables explicativas. A1 hacer estos pronosticos, se han considerado dos escenarios: El primer-el escenario “pasivo”- asume que las variables explicativas continuaran evolucionando durante la decada pr6xima de acuerdo a tendencias historicas pasadas; el segundo-el escenario "active"-asume la implementacion de reformas de politicas que elevan todas las variables explicativas a1 25” percentil superior de su distribucion en AmCrica Latina y el Caribe.

xvii. Bajo el primer escenario, el crecimiento de Guatemala mejoraria ligeramente, de 1.4 por ciento a1 afio en 10s noventa a 2.2 por ciento en promedio para el periodo 2000- 20 10. Este indice se encontraria levemente por debajo de la tasa necesaria para cumplir con la Meta de Desarrollo del Milenio de recortar la pobreza extrema a la mitad para el 2015, tomando el aiio 2000 como base. Bajo el segundo escenario “activo”, Guatemala podria mejorar su indice de crecimiento considerablemente acelerando el ritmo de las reformas clave. Bajo este escenario, el crecimiento del PIB promedio de Guatemala por aiio incrementaria a 5 por ciento en el periodo 2000-2010. Si este indice se lograra sostener, se podria reducir la pobreza extrema en mas de la mitad entre el 2000 y el 2015 (mas de 10 puntos porcentuales), y la pobreza declinaria a aproximadamente 3 1 por ciento.

xviii. La mayoria del aumento en crecimiento en Guatemala bajo el segundo escenario se produciria como resultado de 10s avances en educacion e infraestmctura publica. La mejora en politicas de educacion contribuiria con un aumento en el crecimiento anual per capita de 1.7 por ciento a1 aiio, mientras que aquellos en infraestructura publica aportarian una mejora del 1.1 por ciento. En tercer y cuarto lugar, con un potencial menor de impacto, estan la mayor profbndidad densidad financiera (0.5 por ciento) y apertura comercial (0.4 por ciento). xix. Puesto que cualquier intento de atender simulthneamente a todas las areas pendientes de reforma dispersaria 10s esfuerzos y debilitaria 10s resultados, el ejercicio identifica aquellas areas donde yacen las contribuciones mas altas para el crecimiento. La metodologia indica que el impacto mas grande se materializaria en la siguiente decada si 10s esfuerzos se enfocaran en mejorar el capital humano, la infraestructura, el desarrollo financier0 y la apertura comercial: areas en las que Guatemala se ha quedado considerablemente atras en comparacion con otros paises latinoamericanos y el resto del mundo. Asimismo, Guatemala se ha desempeiiado deficientemente en las areas de gobernabilidad e innovation, y en las que las mejoras hacia a estandares regionales o globales podrian producir sustanciales beneficios economicos. GUATEMALA- CEM xxv Los Desafios de Restaurar un Mavor Crecimiento Econdmieo Resumen Eiecutivo

Crecimiento, pobreza y desigualdad xx. Aunque este reporte esta enfocado en incrementar el crecimiento por su papel de impulsor de la reduccion de pobreza en Guatemala durante 10s pr6ximos aiios, tambien reconoce que el impacto del crecimiento para las familias pobres se ve disminuido por altos niveles de desigualdad. Por tanto, se recalca la necesidad de una agenda de politica de crecimiento con atencion especial a medidas que aseguren que 10s desarrollos hturos beneficien a todos 10s segmentos de las sociedad. Dicha agenda debera incluir la preservacion de una estabilidad macroecon6mica, la prevencion de crisis en el sector financier0 y el financiamiento de una agenda de gasto publico progresiva desde el punto de vista distributivo, con enfasis en inversiones de capital humano e infraestmctura rural, que faciliten el acceso de 10s mas pobres a 10s fmtos del crecimiento.

D. EL PAPEL DEL CAPITAL HUMAN0 xxi. Un conjunto grande de evidencia micro- y macroeconomicas, procedentes de Guatemala y de otros paises, muestra hertes vinculos entre el desarrollo del capital humano, la productividad humana y el crecimiento econ6mico. La evidencia de Guatemala indica que 10s niveles mas altos de educacih, entrenamiento y capacidad, aunados a mejor salud y nutricion, serian las medidas mas efectivas que Guatemala podria tomar para mejorar su crecimiento a largo plazo. El desempeiio del crecimiento hturo tambien se beneficiaria de reducir las enormes desigualdades existentes en el acceso a1 capital humano en el pais. xxii. Guatemala cuenta con unos de 10s indicadores mas bajos en estas areas entre 10s paises latinoamericanos. Aunque se ha logrado algun progreso recientemente, las tasas netas de matricula en educaci6n primaria estan por debajo del 90 por ciento, y en escuela secundaria bisica por debajo del 30 por ciento. Las tasas de graduacion son extremadamente bajas, menos del 40 por ciento en escuela primaria, y las tasas de repeticion son altas. El numero de aiios promedio de educaci6n es el mas bajo de Centroamerica: 3.5 aiios. La calidad de la educaci6n es bastante baja segun las pruebas estandarizadas y el nivel de desigualdad de acceso a la educacih es extremadamente alto (menos de 10 por ciento del quintil mas bajo termina la escuela primaria). Las condiciones son todavia mas alarmantes a1 tratarse de 10s niveles de desnutricih, donde 10s indicadores del pais se encuentran entre 10s peores de Amkrica Latina, con lo cual se reduce considerablemente la capacidad de aprendizaje y de desarrollo productivo de 10s individuos. xxiii. Dados 10s bajos niveles de capital humano, 10s beneficios de 10s que gozan 10s individuos y la sociedad con niveles de educaci6n mas altos son muy elevados. En promedio, un aiio adicional de educacion aumenta 10s sueldos por hora en un 6 por ciento. Las mujeres con diplomas de secundaria ganan 54 por ciento mas que aquellas sin educacion, y 37 por ciento mas que aquellas con educacih primaria. Es importante hacer notar que estos beneficios son privados y no sociales para la educacion, que a priori deberian ser mhs altos. GUATEMALA - CEM xxvi Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo xxiv. Las investigaciones reportadas en este estudio muestran que 10s incrementos en educacion heron la fuerza principal tras el crecimiento de la productividad total de 10s factores durante 10s ultimos treinta afios. El aumento de la mano de obra con ajustes de calidad explica el 78 por ciento de crecimiento del PIB para el periodo. El impacto de la educacion en la productividad se manifiesta a traves de varias vias: (a) mediante mejoras directas en la productividad de 10s trabajadores; (b) a traves de un aumento en las habilidades de trabajadores y empresarios para tomar decisiones apropiadas sobre la combinacibn mas eficiente de insumos y tecnologia en la produccion; (c) a traves de un incremento en la capacidad de adaptarse a 10s cambios en tecnologias, politicas y el ambiente economico externo; y (d) a niveles suficientemente altos de educacion, a traves de la capacidad de generar innovaciones que proporcionen mejoras en la productividad. Los estudios demuestran que las mejoras en productividad ocurren solo una vez que 10s estudiantes logren un cierto nivel de aprendizaje en lenguaje y aritmetica, u obtengan 10s conocimientos cognitivos para tomar decisiones complejas. xxv. Las estimaciones del impacto de la educacion en el crecimiento economico para Guatemala son cuantificables. Los calculos de este estudio demuestran que un aumento de un punto porcentual en el promedio de aiios de educacion elevaria a la produccion en 0.33 por ciento de manera agregada, si el pais pudiera subir su nivel bruto de matricula a niveles comparables de 10s lideres en America Latina, el indice promedio de crecimiento per capita en 10s proximos diez aiios podria aumentar hasta en 1.6 por ciento a1 afio. xxvi. Ademas del nivel de educacion, el estado de salud de 10s individuos es tambien critic0 para su capacidad productiva. La evidencia macroeconomica de Guatemala y otras partes demuestra que la estatura baja para la edad-un indicador de desnutricion cronica- afecta negativamente a la capacidad de aprendizaje de las personas, y su capacidad de llevar a cab0 labores fisicas y de ganarse la vida como adultos. En las areas rurales de Guatemala, el analisis de datos longitudinales indica que una baja estatura para la edad reduce el funcionamiento intelectual de 10s niiios, por lo cual obtienen un desempeiio mas deficiente en las pruebas. Hay estudios recientes que muestran que un mejor nivel de nutricion esta asociado a la obtencion de un mayor nivel de crecimiento en ingresos y tiene un impacto significativo en el crecimiento econdmico agregado. Estos resultados apoyan la idea de que para ser completamente eficiente, las politicas de capital humano para fomentar el crecimiento en Guatemala deberan enfocarse en la salud, especialmente en la desnutricion cronica, ademas de la educacion. xxvii. Las medidas clave necesarias para mejorar el nivel de capital humano incluyen:

Completar la agenda inconclusa de educacion primaria, con hfasis en elevar la calidad de las escuelas primarias, asi como sus indices de retention y graduacion; fortalecer la capacidad productiva del guatemalteco a traves de mejoras del estatus nutricional de la poblacibn; y lograr mayor acceso y participacion en educacion secundaria, para mejorar el posicionamiento de Guatemala en las oportunidades economicas en su horizonte. GUATEMALA - CEM xxvii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo xxviii. Las acciones clave para completar la agenda inconclusa de educacion primaria incluyen:

0 Continuar expandiendo el acceso a la educacion primaria, especialmente a travCs del programa PRONADE; 0 mejorar la calidad de las escuelas para incrementar 10s logros cognitivos, aumentar la eficiencia de la educacion, la retention y 10s niveles de graduacion; Esto requiere: o materiales de aprendizaje bilingues, educacion bilingiie, enseiianza para multiples grados donde sea adecuado y evaluaciones continuas de 10s estudiantes; o mejoras en el entrenamiento y la educacion a travCs del desarrollo de las guias de 10s maestros, entrenamiento durante horas de servicio en el manejo de aulas, entrenamiento de maestros en el desarrollo de un ambiente de apoyo para la educacion de las niiias y en la educacion de 10s niiios indigenas; o mejoras en la calidad de las escuelas a travCs de medidas institucionales para aumentar la participacion comunitaria y la administracion escolar. xxix. En la educacion secundaria la clave es expandir el acceso y la participacibn. Las medidas deben considerar:

0 Responder a las restricciones tanto de demanda como de suministro en el acceso y la participacion en la educacibn secundaria. El analisis indica que aunque 10s factores de la demanda-tales como 10s costos de las escuelas secundarias-representan las restricciones mas severas contra 10s numeros mas altos de inscripcibn en areas urbanas, 10s factores de suministretales como la falta de instalaciones escolares y 10s factores de demanda-son restricciones clave contra las inscripciones en las areas rurales; 0 Fomentar la participacibn del sector privado y las ONGs, asi como la del sector publico, en la distribucion de servicios de educacibn. En contraste con la educacion primaria, donde predomina la provision del sector publico, cerca de 55 por ciento de 10s estudiantes de secundaria asistieron a escuelas privadas y otro 10 por ciento a escuelas cooperativas en el 2000; 0 Adoptar mCtodos alternativos para asegurar el alcance mas amplio de las oportunidades de escuela secundaria, especialmente en areas rurales. Est0 puede incluir, por ejemplo, la expansion del modelo de multiples grados de NEU para abarcar nueve grados, asi como la extensih de oportunidades de aprendizaje a distancia para el nivel secundario (telesecundaria) xxx. Para combatir la desnutricion, es necesario adoptar un enfoque multi-sectorial que confronte las condiciones de nutrich, salud y medio ambiente, y que fomente cambios en el comportamiento. Las recomendaciones son: GUATEMALA- cEh4 xxviii Los Desafios de Restaurar un Mavor Crecimiento Erondmico Resumen Eiecutivo

0 Mejorar la nutricion prenatal a traves de asesoramiento sobre el consumo alimenticio y aumento de peso durante el embarazo, asi como 10s suplementos de hierro y acido folic0 provistos a las mujeres embarazadas;

0 fortalecer las practicas de alimentacion y cuidados de infantes por medio de informacion sobre la lactancia y otros metodos de alimentacion complementarios, asi como actividades para la promoci6n de la salud ambiental, tales como el lavado de las manos y entrenamiento en practicas de manejo higiknico del agua;

0 reducir riesgos ambientales de enfermedades infantiles comunes a traves de mejoras de acceso a1 agua potable y saneamiento, asi como la disminucih de la contaminacion del aire proveniente de las fogatas dentro de las viviendas;

aumentar el acceso a servicios de planificacion familiar de calidad a traves de un aumento en la provision de y acceso a informacih y asesoramiento con relevancia cultural, asi como una amplia gama de metodos de planificacion familiar;

fortalecer y mejorar la supervish de programas de fortificacion alimenticia en todo el pais (i.e., fortificacion de productos basicos con vitamina A, hierro y sal yodada).

0 Mejorar el acceso y el us0 de servicios de salud preventiva y curativa, incluyendo mas inmunizaciones para 10s niiios, supervision de crecimiento, desparasitacih y mejor control de enfermedades infecciosas y enfermedades infantiles comunes.

xxxi. Las medidas de educacion y salud requeriran recursos publicos y privados adicionales, ya que Guatemala ocupa un puesto bajo en el volumen de gasto publico dedicado a1 sector social entre 10s paises latinoamericanos. Los calculos mas conservadores indican que un programa para lograr una educaci6n universal basica con la mejora en calidad necesaria para maximizar el impacto en el crecimiento de la educacion requeriria de un aumento real del 44 a1 48 por ciento en el presupuesto anual de educacih. Puesto que est0 podria ser demasiado ambicioso a corto plazo, el gobierno podria considerar aumentar gradualmente el gasto en educacion, comenzando con un aumento real de 8.3 por ciento, que es lo necesario para alcanzar una educacih primaria universal. Con el tiempo, se deberian seguir aumentando 10s recursos hasta resolver de manera adecuada las limitaciones de acceso, cobertura y calidad de la educacion. En cuanto a1 problema de la desnutricih crhica, las necesidades financieras tambien son considerables. El financiamiento total del paquete de servicios requeridos demandaria dedicar recursos adicionales equivalentes a entre 7.4 y 12.8 por ciento del total de gastos actual en salud en Guatemala.

xxxii. Queda claro que la resolucih de la agenda de crecimiento a traves de estas inversiones requerira de recursos y esfuerzos adicionales considerables para fortalecer la GUATEMALA- CEM Los Desafios de Restaurar un Mavor Crecimiento Econdmico xxix Resumen Eiecutivo entrega de servicios en 10s sectores de educacion y salud. Per0 10s beneficios a largo plazo de estas inversiones adicionales tambien seran grandes.

E. PARA MEJORAR EL CLIMA DE INVERSIONES Gobernabilidad xxxiii. Guatemala ocupa un puesto bajo entre 10s otros paises en las areas de gobernabilidad, imperio de la ley, capacidad institucional, efectividad gubernamental, control de cormpci6n, participacion y responsabilidad. En una encuesta reciente de emprendedores de negocios, 10s obstaculos mas grandes para un buen clima de negocios resultaron ser: el nivel de cormpcion (donde Guatemala ocupa el puesto 100 entre 130 paises), el crimen y la violencia, y la incertidumbre de las politicas regulatorias. Asimismo, una de las razones del bajo desempeiio de la economia en 10s ultimos cuantos afios ha sido el deterioro del ambiente de negocios. El aumento en 10s niveles de violencia y crimen, la cormpcion y la actitud de confrontaci6n del gobierno contra el sector privado en 10s ultimos cuatro aiios han ejercido un freno a las actividades empresariales. xxxiv. Guatemala tendra que hacer esfuerzos en conjunto para poder superar aquellos factores que afectan adversamente a su clima de negocios. La cormpcion es endemica en muchas areas de la sociedad y requiere de esfuerzos conjuntos de parte del gobiemo y la sociedad civil para combatir sus causas. Un mCtodo completo para confrontar a la cormpci6n debera incluir:

0 Transparencia en gastos y compras gubernamentales; 0 Una reforma del servicio civil; 0 La aprobacion de la ley de probidad; 0 Un cumplimiento mayor y mas oportuno de las leyes existentes contra sobomos y la mala utilizacih de fondos; y 0 Una encuesta sobre las fuentes y causas de cormpci6n, junto con el desarrollo de un plan de acci6n. xxxv. En el area de crimen y violencia, es esencial proveerle a la policia, la oficina del fiscal y el sistema judicial 10s recursos adecuados para aumentar el numero de funcionarios oficiales, y la capacidad de investigar y perseguir criminales. Tambien es importante mejorar la coordinacion de investigaciones criminales entre la Oficina del Fiscal y la Policia Nacional Civil. xxxvi. Como se indica, las cargas de las regulaciones, la deficiencia en la calidad de las regulaciones y, en especial, el us0 discrecional de 10s poderes reguladores son algunas de las causas principales del desaliento de las inversiones. Hay una necesidad urgente de:

0 revisar la estmctura de regulaciones en el pais; 0 simplificar las regulaciones y clarificar las normas para las aduanas, administracion de impuestos y asuntos laborales; GUATEMALA- CEM xxx Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resum en Eiecutivo

0 estandarizar el proceso de aprobacion de inversiones; 0 fortalecer 10s esherzos actuales bajo la Agencia para el Foment0 de las Inversiones y el Programa Nacional de Competitividad, especialmente en las areas de organizacion de productores, estandares de calidad y certificacion; 0 poner en marcha una agencia de proteccion a1 consumidor. xxxvii. Un area critica para la mejora del clima de negocios es la modernizacion del sistema judicial. A pesar de 10s esherzos de modernizacion desde que se firmaron 10s Acuerdos de Paz, todavia existen ineficiencias y retrasos considerables que tienen un efecto adverso en el clima de inversiones. Los sistemas de derechos de propiedad y cumplimiento de contratos siguen siendo dCbiles, y 10s acuerdos de resolucion de disputas imponen un costo alto a1 efectuar negocios. El abuso de las apelaciones es uno de 10s problemas m8s serios. Las medidas principales en esta area deberan involucrar:

0 Continuar el proceso de modernizacion del sistema judicial; 0 limitar el proceso de apelaciones en existencia y asegurar que 10s casos se resuelvan dentro de un period0 de tiempo razonable; 0 mejorar el sistema de derechos de propiedad, especialmente la administracion del Registro de Propiedades; 0 desarrollar el sistema alterno de resolution de disputas para casos comerciales; 0 mejorar 10s recursos para el sistema judicial y la eficiencia de su administracion; 0 proveer entrenamiento a 10s jueces sobre el derecho comercial.

Infraestructura xxxviii. La infraestructura del pais ha sido historicamente pobre y ha limitado su potencial de crecimiento. Las mejoras en infraestructura son criticas para aumentar 10s niveles de productividad y crecimiento. Este reporte estima que quizas se podria agregar hasta un punto porcentual a la tasa de tendencia de crecimiento si 10s estandares de la infraestructura del pais se pudieran elevar a 10s niveles de 10s paises lideres en America Latina. xxxix. El papel restrictivo de la infraestructura en el crecimiento potencial del pais se ejemplifica mejor por el estado de su estructura de transporte. En 10s ultimos diez aiios, la extension de la red de carreteras, por ejemplo, ha aumentado en solo 19 por ciento, aunque hub0 un progreso considerable a mediados de 10s noventas. La red clasificada de carreteras del pais es de aproximadamente 14,000 km (las cantidades no-clasificadas son de 12,000 km adicionales). Solo aproximadamente 4,000 km son caminos principales y secundarios. Est0 se traduce a 1.2 km por cada 1,000 personas, una de las cifras mas bajas en la region. Cerca de 13 por ciento de 10s hogares simplemente carecen de acceso a carreteras motorizadas pasables. Estas poblaciones estan limitadas y enfrentan costos altos para acceder a 10s mercados y otros servicios. La estructura de la red de carreteras, que es aun mas deficiente en las ciudades rurales y medianas, tambih ha contribuido a la alta concentration de la poblacion en la ciudad capital. GUATEMALA - CEl!-! xxxi Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo xl. El sistema de puertos en Guatemala sufre mas de ineficiencia que de falta de capacidad de procesamiento. El sistema es una mezcla de participacion de 10s sectores privado y publico, con un puerto (Barrios) esencialmente privado per0 con capacidad limitada, mientras que el puerto en la costa del Pacific0 (Quetzal) se administra a traves de un sistema de concesiones, y el puerto menos eficiente (San Tomas) es operado por el gobierno y maneja la mayor parte de la carga del Atlantico. Este ultimo esta comenzando a enfrentar herte competencia de 10s puertos en paises vecinos, un desan-ollo que indica claramente la necesidad que habra de una integracion regional de servicios. Un servicio critico para el manejo eficiente de comercio extern0 es la administracion de aduanas. Aunque ha habido mejoras en el area, con la creacion de la Superintendencia de Administracibn Tributaria (SAT) y la introduccion de equipo moderno, el sistema continua siendo bastante ineficiente, ya que la carga tiene que esperar un promedio de cinco dias: Un period0 mayor que en otros paises de la region. xli. Se han visto mejoras considerables en muchas areas de infraestructura en 10s ultimos cuantos aiios. Dos sectores importantes (telecomunicaciones y electricidad) se han expandido considerablemente desde que heron parcialmente privatizados y liberalizados a mediados de 10s noventas. A1 remover la posicion de monopolio del estado en las telecomunicaciones en 1996 y la privatizacion posterior de la compaiiia telefonica, se logro un crecimiento de cobertura sin precedentes. El numero de lineas fijas, por ejemplo, ha aumentado en mas del triple, de 286,000 en 1994 a 750,000 en el 2001. El numero de lineas por cada 100 personas es ahora 6.5. El crecimiento en telefonia celular has sido todavia mas impresionante. En 1995, solo habian alrededor de 30,000 telefonos celulares en el pais, y para 2002 el numero habia aumentado a 1.14 millones. De forma similar, el numero de compaiiias que operan en el pais ha aumentado (a 21), y el precio y el tiempo de instalacion y llamadas se ha visto reducido dramaticamente. Todavia existen deficiencias en telefonia rural, donde la cobertura es muy baja y el estado todavia soporta el programa principal de extension de cobertura y capacidad de supervision, el cual ha estado paralizado por la falta de presupuesto, mejor capacidad tecnica y poderes reguladores mas fuertes. xlii. Se ha visto un progreso considerable en cobertura electrica desde que se introdujeron las reformas a mediados de 10s noventas. Desde entonces, Guatemala ha gozado de un progreso rapido y significativo en cobertura electrica. La capacidad instalada ha ido aumentando constantemente de 1,314 MW en 1996 a 1,670 MW en el 2002, equivalente a un incremento del 27 por ciento. Las mejoras en eficiencia y la implementacion de un programa de electrificacion rural han resultado en un aumento significativo en cobertura electrica de 53 por ciento en 1996 a un 85 por ciento de 10s hogares conectados en el 2002 (el segundo nivel m6s alto en America Central, despues de Costa Rica). El servicio ademas ha mejorado. xliii. El tema critico en electricidad ahora son 10s niveles tarifarios. Con la privatizacion de la distribucion y la liberalizacidn de 10s productores, 10s principios de recuperacion de costos tambien se aplican a1 establecimiento de tarifas. Los consumidores grandes ahora pueden comprar electricidad directamente de 10s productores a precios negociados. Los consumidores mas pequeiios tienen subsidios. De hecho, la ley hasta hace poco establecia un indice social bajo para el consumo menor a 300 kWh a1 mes. El limite GuATEM~LA- CEM xxxii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo era algo alto y cubria a 90 por ciento de 10s hogares y a 43 por ciento de la energia distribuida. El gobierno bajo el umbral a 100 kwh, una medida que ha enfrentado gran resistencia. Como resultado de las tarifas desiguales, 10s consumidores medianos de electricidad, principalmente empresas pequefias y medianas, pagan tarifas considerablemente altas (entre 25 a 70 por ciento mas que cualquier otro pais centroamericano). Esto esta afectando sus puestos de competitividad. xliv. La cobertura y la calidad de la infraestructura del pais difieren considerablemente. Los beneficios de invertir en infraestructura son especialmente altos en areas rurales, donde 10s indices de cobertura son bastante bajos. Puesto que un 61 por ciento de la poblacion reside en areas rurales y 75 por ciento de 10s habitantes rurales viven en pobreza, la mejoria de 10s niveles de vida de 10s guatemaltecos rurales es clave para el crecimiento y el futuro del pais en general. Existen grandes desigualdades en la cobertura de servicios de infraestructura urbano-rural. Aunque 10s servicios de agua y electricidad son casi universales en las areas urbanas, solo llegan a un poco mas de la mitad de 10s hogares rurales. Un estimado de un 30-40 por ciento de la poblacion rural no cuenta con servicio de agua y mas de 50 por ciento no tiene una instalacion moderna de saneamiento. xlv. Estas cifras de cobertura no logran demostrar la calidad limitada de servicios existentes; la mayoria de 10s sistemas de agua rurales no transportan agua potable, operan con estructuras deficientes de administracion y carecen de tarifas adecuadas. La mayoria de 10s hogares en las areas rurales no tienen acceso a carreteras motorizadas o a transporte publico durante todo el aiio, lo cual agrava mas su aislamiento y falta de oportunidades. Se estima que en las carreteras rurales que proporcionan acceso a 10s mercados, 10s productores gozan de tasas de retomo de cerca del 15 por ciento. En 10s ultimos cuantos aiios, la restriction presupuestaria ha resultado en un declive de inversiones en infraestructura, y la calidad se ha deteriorado visiblemente. Menos de una tercera parte de las carreteras rurales reciben rehabilitation o mantenimiento de rutina cada aiio. El servicio elkctrico en las areas rurales es generalmente de una sola fase, limitando las oportunidades de usar equipo de produccion como motores o molinos. Aunque 80 por ciento de las comunidades rurales se encuentran dentro de un radio de 6 km de un telkfono publico comunitario, so10 6 por ciento de 10s hogares rurales cuentan con telkfonos fijos o moviles. xlvi. Los principales retos que enfrentan las autoridades en el sector de infraestructura son extender la cobertura en las areas rurales, modemizar y mejorar la eficiencia de varios sectores y aumentar la participacion de 10s inversionistas privados y 10s gerentes en algunos de 10s sectores. Tambikn es importante revisar temas de tarifas y fortalecer la estructura regulatoria. xlvii. Este Memorando Econbmico del Pais (CEM) analiza 10s prospectos y las politicas en las diferentes areas de infraestructura. Varios de 10s sectores en infraestructura todavia confrontan temas basicos de cobertura y deficiencia en calidad. Este es especialmente el cas0 en aquellos sectores que no han pasado por 10s importantes procesos de modemizacion y reforma, tales como el transporte, incluyendo puertos y aduanas, y 10s servicios de agua y saneamiento. Las recomendaciones de politicas para cada sector especifico se describen a continuacion. GUATEMALA - CEM xxxiii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo xlviii. En el sector de las telecomunicaciones, el progreso logrado hasta ahora se podria sostener y mejorar con iniciativas en las siguientes areas:

0 Mejorar la gobernabilidad reguladora y el poder de las agencias reguladoras, especialmente para garantizar el comportamiento competitivo de las firmas dominantes; y 0 mejorar 10s mecanismos de participacion privada en infraestmctura telefonica rural. xlix. En el sector electrico, las acciones prioritarias para 10s proximos aiios deberan incluir lo siguiente:

0 preservar la definicion actual de la tarifa social, y proveer subsidios exclusivamente a 10s mas pobres; 0 afinar el marco regulador, especialmente para proporcionar incentivos para inversiones a largo plazo y el us0 eficiente de la energia; 0 fomentar agresivamente la implementacion del Programa de Electrificacion Rural y decidir 10s mecanismos de financiamiento que permitan soluciones con y sin conexion a la red electrica, para proveerle electricidad a 10s hogares que aun no la tienen; e 0 ingeniar mecanismos para aumentar el acceso a usos de produccion y servicios de micro-finanzas para permitir que 10s clientes generen ingresos a traves del us0 de servicios de infraestmctura tales como la electricidad.

1. En el sector de transporte el acceso es un tema clave, ya que el pais es predominantemente rural. En este sentido, sera necesario lo siguiente:

0 Extender la cobertura selectivamente dentro de la estrategia apuntando a fortalecer 10s vinculos rurales-urbanos y desarrollar 10s corredores de comercio; 0 reducir 10s riesgos de cambios en la regulacih para permitir que el sector privado participe en la constmccion, operation y mantenimiento; 0 implementar un marco regulatorio adecuado (a traves de la aprobacion de la ley de concesiones) e introducir la capacidad institucional (unidad de concesion independiente) para atraer a 10s participantes privados. li . Otro tema es el impacto del ajuste fiscal en 10s recursos para el mantenimiento de las carreteras. Se deben mantener niveles minimos de mantenimiento para evitar el deterioro excesivo y 10s gastos mas altos de recuperacion asociados con esto. Una alternativa podria ser conseguir fondos para COVIAL y hacerla una institucion autonoma para evitar interferencia politica. Igualmente se debera fortalecer la capacidad de planificacion a1 nivel central y local. lii. En el sector de puertos, la politica deberh involucrar, entre otras, las siguientes prioridades:

0 Reducir la interferencia politica en 10s puertos administrados publicamente a traves de mejoras en la participacion de usuarios en 10s comites ejecutivos; G~~ATEMALA- CEM xxxiv Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo

0 introducir disciplina financiera y modernizar el proceso de administracion en 10s puertos publicos con la debida atencion en la administracion de recursos humanos, productividad y transparencia (si la privatizacion no es factible); 0 tomar medidas, a traves de la eliminacion de 10s obstaculos actuales, para reducir el tiempo necesario para la carga y descarga de mercancia en 10s puertos; e 0 implementar reformas reguladoras e institucionales para facilitar la participacih privada, talvez comenzando con la extensidn de 10s puertos (por ejemplo, Puerto Quetzal debido a1 problema de saturacion). liii. La reforma de aduanas se debera enfocar en dos prioridades principales. La primera es la implementacion de una estrategia de reforma de aduanas para mejorar el intercambio comercial, posiblemente a traves de la implementacion de un sindicato de aduanas de America Central. La segunda es el reforzamiento de la credibilidad de las aduanas finalizando el proceso de modernizacion, intensificando el entrenamiento e implementando una administracion basada en calidad. liv. En el sector de agua y saneamiento hay varias medidas que podrian mejorar la cobertura y la calidad de 10s servicios. Las mas importantes son:

Reformar el marco legal e institucional para clarificar 10s papeles de las diferentes instituciones gubernamentales; obtener la aprobacion de una Ley de Agua, definiendo a1 Instituto Nacional de Agua Potable y Saneamiento, como el creador de politicas; a la Comisidn Nacional del Agua Potable, como el ente regulador, y con la participacion de proveedores publicos, privados o publico-privados para la provision de servicios; reducir la incertidumbre a1 asignar la responsabilidad de asignar las concesiones a la Comision Nacional de Agua Potable. Esto aumentaria la transparencia en el sector y clarificaria el papel que juega el sector privado. Este asunto es mas relevante en areas urbanas e industriales donde el potencial de crecimiento economico es mas grande que en las zonas rurales. Aumentar el financiamiento publico para mejorar el acceso a 10s sistemas de agua y saneamiento en las areas rurales, 10s proyectos de financiamiento bajo el Modelo Basico, que han comprobado ser las medidas mas adecuadas.

Desarrollo financiero lv. Hay evidencia de un vinculo causal entre la prohndidad y la solidez del sector financiero y el crecimiento economico. Los mercados financieros influyen en la eficiencia y el crecimiento economico a traves de diferentes canales, ayudando con la movilizacion de ahorros y la identificacion de proyectos de inversiones rentables. En Guatemala las mejoras en la cobertura del sector financiero, a niveles comparables con 10s lideres en America Latina, podrian aiiadir medio punto porcentual a1 indice de crecimiento por aiio en 10s proximos diez aiios. lvi. Aunque ha habido progreso en aiios recientes en el proceso de reformas del sector financiero, Guatemala todavia muestra niveles bajos de profundidad financiera. El GUATEMALA - CEM xxxv Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resumen Eiecutivo volumen de crkdito a1 sector privado solo alcanza alrededor de un 22 por ciento del PIB, por lo cual se puede decir que el sistema financiero de Guatemala es subdesarrollado en comparacion con paises de su mismo nivel de desarrollo. lvii. El sistema financiero esta dominado principalmente por bancos privados que operan a1 centro de conglomerados financieros, 10s cuales muchas veces incluyen bodegas, compaiiias de seguro y compaiiias de garantia. Los bancos representan 91 por ciento de 10s activos del sistema regulado. Se dice que la mayoria de 10s bancos privados grandes y medianos cuentan con un banco extraterritorial (“offshore”) como parte del grupo, y la mayoria de 10s conglomerados financieros grandes esth integrados en grupos economicos mas amplios, dominados por familias. El sector pcblico so10 goza de una pequeiia participacion en el sector financiero, per0 10s bancos publicos confrontan retos especiales. Hay un sistema sin regulacion relativamente grande, compuesto principalmente de compaiiias de arrendamiento, factoraje y tarjetas de crkdito. lviii. El sistema financiero guatemalteco es solido en tkrminos generales y esta posicionado para un proceso de modernization. Un conjunto reciente de reformas, especialmente a travks de la aprobacion de una moderna e importante legislacion ha establecido las condiciones para una expansion y consolidacion mas solidas. Las nuevas leyes mejoraron el proceso de autorizacion de licencias a intermediarios bancarios; consolidaron la supervision y regulacion de grupos financieros, incluyendo bancos extraterritoriales (offshores); fortalecieron el marco regulador y las nonnas prudenciales; mejoraron la gobernabilidad y la transparencia de las instituciones bancarias; y limitaron el sistema de seguros de depositos. Tambikn garantizaron la independencia del Banco Central, definieron claramente su papel y aseguraron las medidas de liberalizacion de 10s mercados de capital que habian ocurrido anteriormente por decretos ejecutivos. lix. Como resultado de las leyes, se han dado resultados importantes, tales como mejoras en supervision consolidada, la formacion de grupos financieros consolidados y la creacion de un fondo fiduciario para asistir en las hsiones y adquisiciones. Sin embargo, todavia es necesario considerar otras tareas, tales como:

0 Inspeccionar 10s bancos extraterritoriales (offshore);

0 Otorgar licencias a un numero de conglomerados financieros y bancos extraterritoriales; 0 Hacer que el marco de resoluciones de bancos pueda operar en la practica, para lo cual se necesita eliminar del pago del IVA a aquellas transacciones financieras asociadas con hsiones o adquisiciones; 0 Aprobar otras modificaciones legales pendientes e importantes para completar las reformas tales como aqukllas relacionadas con intermediarios financieros no-bancarios y garantias mobiliarias. lx* Uno de 10s retos mas grandes del sector financiero es aumentar la cobertura en areas rurales y mejorar el us0 de colaterales y garantias, especialmente entre la poblacion rural. Solo 13 por ciento de 10s hogares rurales solicitaron y recibieron algun tipo de prestamo, segun una encuesta del aiio 2000 y solo 10 por ciento de 10s hogares sin tierras solicitaron y recibieron prkstamos, en comparacion a 15 por ciento de 10s hogares con GuATEIMALA - CEM xxxvi Los Desafios de Restaurar un Mavor Crecimiento Eeondmico Resumen Eieeutivo tierras. Los pobres tienen poco acceso a terrenos con titulos que les puedan servir de garantia, con lo cual se limita la obtention de creditos para compras de insumos o para la diversificacion de sus actividades economicas. Solo una tercera parte de 10s pobres tienen titulos de propiedad, comparados con casi la mitad de la poblacion que no es pobre. La falta de garantias es una de las razones mas frecuentes por la que 10s hogares no solicitan prestamos. Los bancos del sistema tienen la mayoria de sus operaciones concentradas en las areas urbanas. Solo unos cuantos cuentan con cobertura nacional y presencia en las areas rurales. El pais cuenta con una industria micro-financiera vibrante, per0 su cobertura todavia se encuentra un tanto limitada, con menos de 100,000 clientes). La red de cooperativas de credit0 cubre a otros 450,000 clientes. lxi. La presencia mas importante en las areas rurales le corresponde a Banrural, un banco de propiedad mixta publico-privada. La institucion ha crecido rapidamente, de 90 sucursales en el 2000 a mas de 250 a finales del 2003. Aunque su declaration de objetivos identifica su meta principal como prestamos para la micro-, pequeiia y mediana empresa, so10 26 por ciento de sus activos totales estan invertidos en estas. Lamayoria de 10s demhs activos se encuentran colocados en instrumentos de inversion a corto y mediano plazo. lxii. Para apoyar la expansion de las finanzas rurales son se requiere tambien impulsar en el Congreso 10s proyectos de ley de Catastro y sobre Garantias Mobiliarias, junto con la aceleracion del programa catastral y la modernizacion del Registro. Asimismo, el mercado de micro-finanzas se podria beneficiar de un sistema mas transparente y de su transformacion hacia un esquema de micro-finanzas bajo supervision formal.

F. TECNOLOG~AE INNOVACION lxiii. Las areas mencionadas anteriormente contribuyen de maneras distintas a1 crecimiento, muchas a traves de su impacto en productividad. Como se ha mencionado, la clave de aumentar las tasas de crecimiento per capita con el tiempo est& en aumentar la productividad total de 10s factores. Dos de las fuerzas impulsoras mas importantes de la productividad son la introduccion de nuevas tecnologias y 10s procesos de innovacion. Estos factores muchas veces no se discuten dentro del marco de crecimiento economico en Guatemala. De hecho, Guatemala hasta ahora esti empezando a enfocarse en la importancia de la tecnologia y la innovacion en el context0 del desarrollo futuro del pais. lxiv. Hay varios factores que limitan la mejora tecnologica y la innovacion en Guatemala. El sistema nacional de innovacion, a travCs de las redes de 10s centros cientificos y tecnologicos, es bastante limitado. El bajo nivel de integracion internacional restringe la capacidad de las firmas de conseguir tecnologia y las limita a obtenerla por medio de la importacion de maquinaria y/o a traves de contactos con proveedores. El volumen de recursos que se gasta en tecnologia directa representa menos del 2 por ciento de las ventas de las firmas, y la base de conocimientos y las habilidades de la fuerza laboral en la absorci6n de la tecnologia son bastante bajas. GUATEMALA- CEM xxxvii Los Desafios de Restaurar un Mavor Crecimiento Erondmiro Resunren Eierutivo

lxv. Los principales problemas que son identificados por las firmas como impedimentos para la compra de nueva tecnologia son las regulaciones e impuestos gubernamentales, la falta de fondos para la adquisicion de nueva tecnologia, la falta de personal calificado para usar nueva tecnologia y la falta de oportunidades para interactuar con compaiiias similares. La ultima razon es especialmente limitante para las firmas pequeiias (52 por ciento); un factor que demuestra 10s beneficios que se podrian derivar de medidas para fomentar la colaboracion a traves de incubadoras, parques tecnologicos y clusteres. Para la compra de nueva tecnologia las empresas tienden a utilizar recursos propios y las firmas pequeiias gozan de poco acceso a1 financiamiento bancario.

lxvi. Hay muchas medidas que se pueden contemplar para mejorar la capacidad del pais para inducir innovaciones tecnologicas. Sin duda alguna, existe la necesidad de aumentar el nivel de destrezas de la fuerza laboral. Sin embargo, esto es algo que deberan llevar a cab0 principalmente las empresas privadas con una participacion limitada de INTECAP, cubriendo solo a aquellos en busqueda de empleos. Otra area donde se pueden obtener rendimientos considerables seria la facilitacion de actualizaciones de productos a traves de un programa mejorado de certification de calidad.

lxvii. El gobierno tambien podria enfocar el trabajo de CONCYT en aquellos programas que mejoren la dihsion tecnologica en la pequeiia y mediana empresa, y expandan el papel del sector privado en 10s comites consultivos. El gobierno tambien podria eliminar las limitaciones existentes en las importaciones, para la compra de maquinaria y equipos, asi como ajustar su politica de inversion extranjera para atraer mas inversion con intensidad tecnol6gica. Tambien se deberia fortalecer la gobernabilidad de la politica en esta area, definiendo una politica explicita de tecnologia e innovacion, mejorando el papel de creacion de politicas de SENACYT, y simplificando las concesiones de 10s fondos p~blicospara investigaciones y desarrollo.

G. PARA APROVECHAR LAS OPORTUNIDADES DE COMERCIO

lxviii. El analisis preparado para este estudio corrobora que la expansion del comercio juega un papel critic0 en estimular el crecimiento y la reduccion de la pobreza. Un regimen abierto en materia comercial y de inversiones fomenta la integracion a1 entorno de comercio global y la importacion de tecnologias diversas y modernas que son importantes para las mejoras de productividad. Para Guatemala, la expansion del comercio es critica porque permite que la economia supere las limitaciones de especializacion y crecimiento de productividad, impuestas por el tamaiio reducido del mercado nacional.

lxix. Guatemala experiment6 algh progreso en cuanto a su apertura comercial en 10s noventa. Los flujos comerciales (exportaciones mas importaciones como porcentaje del PIB) aumentaron en 11 puntos porcentuales entre 1991 y el 2001. Sin embargo, la mayor parte de este progreso solo se puede atribuir a1 crecimiento de las importaciones, ya que las exportaciones totales han permanecido practicamente estancadas durante 10s ultimos diez aiios, en alrededor de 19 por ciento del PIB, a pesar de desarrollos positivos en exportaciones de maquilas y otros productos no-tradicionales. GUATEMALA - CEM xxxviii Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resum en Eiecutivo lxx. El relativo estancamiento en aiios recientes de las exportaciones es el resultado de diferencias significativas en las dinamicas de tres sectores diferentes. El primero es el sector de maquilas, que ha demostrado un crecimiento impactante desde 1990, con exportaciones netas que han aumentado constantemente como resultado de las preferencias comerciales de Estados Unidos y el exito de 10s regimenes de las zonas de libre comercio en atraer inversion extranjera. El segundo es el gmpo de productos de exportaciones tradicionales (i.e., cafe, banano, azlrlcar y cardamomo), el cual esta compuesto por productos que experimentaron caidas continuas en sus volumenes comerciales durante 10s noventa, como consecuencia de un crecimiento lento en su demanda y precios bajos en productos primarios. El tercer0 es el sector de exportaciones no-tradicionales (Ej., flores, vegetales de temporada, frutas y cultivos organicos), las cuales se desempeiiaron con dinamismo hasta el 2000, desde cuando han sido afectadas por un crecimiento mas lento en la economia internacional. A pesar de estas tendencias mixtas, el rapido crecimiento de las exportaciones no-tradicionales en aiios recientes han hecho de Guatemala uno de 10s exportadores mas diversificados de Centroamkrica. lxxi. El estancamiento de 10s flujos de exportaciones desde 1990 y el deficiente ritmo del crecimiento economic0 en 10s ultimos cuantos aiios sugieren que el potencial comercial en la economia guatemalteca todavia no ha sido plenamente explotado. Incluso el dinamico sector de maquilas, que depende enormemente de insumos importados, todavia no ha desarrollado vinculos suficientemente fuertes con el resto de la economia. Un reto clave para el futuro sera aumentar y diversificar el intercambio comercial para poder mejorar el crecimiento economico y la reducci6n de la pobreza. lxxii. El desempeiio mediocre de las exportaciones de la ultima decada no se le puede atribuir a las politicas comerciales, ya que en este ambito se ha logrado un progreso substancial desde finales de 10s ochenta, particularmente en la reduccion de 10s aranceles, y en la eliminacibn de la mayoria de las barreras no-arancelarias, incluidas las licencias e impuestos de exportaciones, asi como 10s controles de precios nacionales y de cambios de divisas. Estas politicas se han complementado con un regimen mas abierto de inversiones extranjeras y uno mas flexible del tip0 de cambio. En el ambito de las importaciones, todavia continuan algunos picos arancelarios (particularmente en agricultura) per0 el us0 de las barreras no-arancelarias no es significativo, con la excepcion de algunas cuotas asociadas en 10s productos agricolas sensibles. El acceso preferencial a1 mercado de 10s Estados Unidos ha generado un crecimiento considerable de 10s productos de maquilas y agricolas no-tradicionales. Los ultimos tambien se han beneficiado de 10s incentivos a las inversiones de 10s regimenes de zonas francas. Queda claro que 10s obstaculos a una respuesta agregada mas robusta del comercio a las crecientes oportunidades en el extranjero estan mas alla de la angosta esfera de las politicas comerciales. lxxiii. Guatemala y 10s Estados Unidos terminaron negociaciones para el CAFTA a finales del 2003. El tratado debera entrar en vigencia despues de la ratificacih en 10s congresos, esperada para el 2005. Aunque Guatemala ya goza de una politica de apertura comercial, el CAFTA ofrece nuevas oportunidades, asi como desafios, que podrian tener un impacto profundo es sus prospectos de desarrollo. El CAFTA expandira las oportunidades de aumentar las exportaciones, las inversiones, el crecimiento y 10s empleos, a1 proporcionar un acceso mas amplio y estable a la economia de mercado mas GUATEMALA - CEM xxxix Los Desafios de Restaurar un Mavor Crecimiento Econdmico Resum en Eiecutivo

grande del mundo. En especial, el CAFTA proveera un amplio marco para las relaciones comerciales e inversiones entre 10s Estados Unidos y 10s paises centroamericanos, las cuales seran considerablemente mas completas y amplias que las preferencias unilaterales actuales bajo la iniciativa CBI.

lxxiv. El CAFTA es una iniciativa que promete brindar oportunidades para la expansion del comercio y las inversiones, y por ende, el crecimiento y la reduccion de pobreza. Es factible que el CAFTA mejore el acceso a1 mercado de algunos productos guatemaltecos, ademas de volver permanentes las preferencias unilaterales que se ofrecian en el pasado a travks de la CBI. Asimismo, se espera que la naturaleza mas amplia del tratado consolide permanentemente muchas de las amplias reformas realizadas en el pasado y asi envie una seiial fuerte de estabilidad y seguridad a 10s inversionistas.

lxxv. Asumiendo que Guatemala pueda replicar so10 una parte de la experiencia de Mkxico bajo el NAFTA, donde el incremento en el indice de apertura comercial sub% de 33.3 por ciento del PIB en 1994, a 53.1 por ciento en 1995 y a 63 por ciento en el 2002, el aumento en el nivel de crecimiento economic0 podria ser significativo. Con solo la mitad de este aumento en apertura comercial, la tendencia de crecimiento per capita en Guatemala podria aumentar hasta en 0.4 por ciento por aiio en la proxima dkcada. Con respecto a1 impacto en el sector agricola, que es el mas sensible, el estudio descubrio que Guatemala exhibe una ventaja comparativa en 261 categorias de productos, que representan 80 por ciento de las exportaciones agricolas. Muchos de estos enfrentan barreras que se deberian eliminar con el tiempo. En cuanto a las importaciones, el impacto agregado de beneficios podria ser positivo debido a que el pais es un consumidor net0 de aquellos productos que se verian mas afectados, tales como maiz amarillo, arroz, frijoles, carne de res y de aves. Se debe tener en cuenta, ademas, que el impacto fiscal de las reducciones en aranceles podria llegar a cerca de un 0.5 por ciento del PIB y requerira de medidas fiscales compensatorias.

lxxvi. Es importante tener en cuenta que el CAFTA por si solo no es suficiente para generar la gran inversion y respuesta comercial necesarias para elevar la tendencia de crecimiento descrita. Las lecciones aprendidas de la experiencia en Mkxico y otros paises indican que Guatemala necesita mejorar las politicas en algunas areas clave y realizar algunas inversiones para asegurar que el potencial del CAFTA en desarrollo economico y social se pueda materializar. Las acciones necesarias para explotar las ganancias esthticas y dinamicas de este acuerdo coinciden ampliamente con la agenda que se detalla en este estudio para fomentar el crecimiento. Tambikn representan las medidas necesarias para remover 10s frenos que han impedido un crecimiento mas robusto del comercio en 10s Cltimos aiios. Para poder optimizar las ganancias comerciales y de crecimiento del CAFTA, las politicas complementarias deberan incluir, primero, mejorar 10s niveles y la calidad de la educacion. Segundo, aumentar la productividad de 10s esfuerzos de investigacibn. Tercero, resolver las deficiencias en infraestructura y mejorar la eficiencia de las aduanas. Cuarto, mantener la estabilidad macroeconomics. Quinto, fortalecer el desarrollo institucional y mejorar las estructuras de gobernabilidad. Sexto, asegurar que 10s guatemaltecos en desventaja no sufran innecesariamente durante la transition a1 libre comercio con 10s Estados Unidos y que las pequeiias y medianas empresas tengan apoyo para gozar de 10s beneficios de un intercambio comercial mas grande. GUATEMALA- CEM xl Los Desafios de Restaurar un Mavor Crerimiento Econdmieo Resumen Eiecutivo

lxxvii. Finalmente, Guatemala tambien necesitara actualizar sus politicas y regulaciones, en aquellas areas en las que no cumplen con 10s requerimientos del CAFTA. Estas incluyen mejorar la transparencia, competitividad y no-discriminacih en el proceso de adquisiciones y contrataciones gubernamental; remover 10s aranceles y otras exenciones en insumos importados para productos que se exporten; y hacer cumplir con mayor efectividad 10s derechos de propiedad, asi como 10s estandares laborales y ambientales.

Chapter I. Introduction: Stylized Facts and Determinants of Growth

I.Introduction 1.1 This Country Economic Memorandum (CEM) is a part of a series of studies prepared periodically by the World Bank on economic issues of its member countries. The last CEM for Guatemala (Building Peace with Rapid and Equitable Economic Growth) was issued in 1996, at a time when the Peace Accords were being finalized. It presented an economic agenda to help build and solidify the peace process. Many of those proposals have been carried out in the last few years, but much ofthe agenda remains to be completed.

1.2 The Peace Accords were based on the premise that Guatemala could grow at a rate of 6 percent per year. Unfortunately, the economic growth performance since 1996 has not matched these expectations. Particularly disappointing has been the experience since 2000, as progress in improving per capita incomes and reducing poverty has all but halted. While there has been improved social well being after the Peace Accords, individuals have not seen these benefits translated into better jobs and higher incomes. The challenges confronting Guatemala today are thus to restore higher growth rates, accelerate the reduction in poverty and generate tangible economic benefits.

1.3 The World Bank and several Guatemalan institutions carried out important work on poverty issues contained in the report “Poverty in Guatemala” (World Bank, 2003). That report concluded that without economic growth, no significant progress in reducing high levels of poverty would be achieved. This Country Economic Memorandum takes up the challenge of diagnosing the causes behind the stagnation of growth of recent years, prioritizing the areas that require most urgent attention and laying out an agenda for policies and reforms required to boost growth.

11. Background A. General Context

1.4 Guatemala is the largest country in Central America with a population of 11.2 million. Approximately forty percent ofthe population is indigenous, and most ofthe population (54%) lives in rural areas. The country is characterized by a large number of ethnic groups who speak distinct idioms. With a growth rate of 2.7% per annum, Guatemala’s population is relatively young, with 49 percent under 18 years old. These demographics pose particular challenges, including growing demands on public services and the need for better economic opportunities in the future.

1.5 The Guatemalan economy is also the largest in Central America and ranks third in the region on a GDP per capita basis. Guatemala’s GDP in 2002 reached a level of over US$ 23 billion, with economic activity distributed mainly between commerce (24%), agriculture (22%) and manufacturing (1 3%). Economic growth since 2000 has averaged 2.5% per annum, which was below the rate of growth of the population. GDP per capita income, in dollar terms, stands at $1,740, placing Guatemala 112 among the 208 economies ranked by the World Bank according to per capita income measures. 2

1.6 Despite its middle-income status, Guatemala displays poor social indicators relative to other nations in Latin America, reflecting a skewed income distribution pattern. With a Gini Coefficient for income of 0.57 (the second highest in Latin America and one of the highest in the world), the top quintile ofthe population accounts for 54% oftotal consumption, while the bottom quintile accounts for only 5% of the total. Education attainment is extremely low (4.3 years on average), and despite recent advances in net enrollment in primary education (reaching 82 percent), the illiteracy rate continues to be high at around 31% ofthe population. Health indicators are similarly poor, with only 60 percent ofthe population enjoying access to basic health care services. Malnutrition rates among Guatemalan children are abysmally high and maternal and infant mortality rates are among the highest in Latin America.

1.7 The country also has one ofthe highest poverty rates in Latin America. Approximately 56% of the population is currently below the poverty line and 16% lived in extreme poverty, according to the 2000 household survey. Poverty is higher among indigenous groups (76%) and is almost three times greater in rural areas (over 86% of the poor live in the countryside). Close to 80% of the poor have been in those conditions permanently, revealing that poverty is endemic and ingrained.

1.8 Poverty and poor social indicators in Guatemala are associated with historical patterns of exclusion, lower levels of education, the lack of access to physical assets (including basic utility services, land and housing), the low productivity of labor and the weak social capital. The Poverty Assessment (World Bank, 2003) provides a thorough analysis of the factors that have contributed to the high incidence of poverty. Besides the array of factors mentioned, geographic location and household size are also found to be important correlates of poverty. Disparities in asset accumulation over time have been found to be the main source of the existing income inequality, with unequal education assets accounting for over half of overall inequality.

1.9 The recent was marred by the long internal civil strife, which ended with the signing of the Peace Accords in 1996. The conflict had destructive consequences on the social and economic structure of the country. The conflict deepened the historical divisions that had prevailed in the country and ushered a period of insecurity, fear, and mistrust; all factors that debilitated the social capital in the country. Furthermore, the development of institutions was thwarted and governance, particularly the rule of law, weakened. Perhaps the greatest long-term economic consequence of the conflict was the displacement of a large segment ofthe population, which has been estimated at upward of one million people. This heled migration flows, not only internally from violence-ridden regions to and other areas of the country, but also to neighboring countries and the United States. As a result, flows from Guatemalans abroad have grown in importance in recent years as a source of foreign exchange for the economy and as an income source for rural families.

1.10 The conflict ended with the signing of the Peace Accords in 1996. The Accords outlined a broad and inclusive development agenda for the country. It contained multiple targets and focused on the needs of the indigenous and rural populations who were most affected by the conflict and suffered the greatest from exclusion in the past. The Accords, 3 however, did not provide a road map on how to achieve many of these outcomes, leading to considerable debate on how to fulfill the multiple goals.

1.11 Many of the Peace Accord targets were predicated on the assumption that the country would attain 6 percent real economic growth, at least over the implementation period (originally 4 to 6 years). Such high growth rates were hoped for after the cessation of the armed conflict and with an expected large influx of external funding following the signing of the agreement. The broad agenda of the Accords included commitments, particularly in the social areas and with respect to social spending, that could have only been fully reached with a favorable growth performance. Unfortunately, the economic growth performance of the country since 1996 has been disappointing, with GDP growing at an average of 3.5 percent per annum. The factors contributing to this slow down are analyzed below.

1.12 While growth has been less than expected, there have been some important achievements under the Peace Accords, particularly in the social areas. The targets for increases in education and health spending have been attained, reflecting an improvement in education coverage and the expansion of health services. Similarly, public investments have also shown gains, especially through the provision of some basic infrastructure. Today, about 70% of the households have piped water and electricity, and almost 90% have some kind of basic sanitation, though fewer than half have sewerage.

1.13 Despite the improvements in the last few years, much remains to be done, and the current challenge is to convert the peace process into tangible benefits to the population. For this, the country must achieve higher economic growth and offer greater opportunities of employment and income generation. The key challenge remains to provide opportunities to a relatively young population that will join the labor force pool rather quickly.

B. Historical Economic Performance

1.14 Guatemala has experienced reasonable growth performance in the last few decades in the Latin American context. As shown in Table 1.1, GDP has grown slightly above 4% per annum since 1950, with GDP per capita averaging 1.3%. Broad fluctuations have followed a similar pattern to the rest ofthe region: during the sixties and seventies, economic growth was robust (averaging 5.5% per year), followed by a strong setback in the eighties, when growth rates of GDP per capita were negative as a result of disruptions caused by the internal conflict and the exhaustion of the early phase of import substitution. In the nineties, growth performance improved significantly, with output growth rate averaging 4.1% from 199 1 to 2000 as compared to 1.0 YOduring the eighties. However, growth levels have not returned to the levels achieved in the 1960s and 1970s. 4

Table 1.1: GDP Growth Rates in Guatemala and LAC Growth rates of Growth rates of GDP 1 GDP per capita LAC GTM GTM GTM I LAC I LAC 1960-1970

1971-1980

1981-1990 221.8 17.7

1991-1999

Source: Loayza, Fajnzylber y Calderon (2002).

1.15 In terms of overall macroeconomic performance, actually Guatemala has had a slightly better record than most Latin American countries. Inflation has been relatively low by Latin American standards, averaging 9.5 YOin the last forty years. The country has not endured a major macroeconomic crisis comparable to those experienced by other countries, and it has managed conservatively its fiscal accounts. Guatemala boasts one of the lowest public sector debt ratios in the region, at 22% of GDP, although its debt servicing capacity (tax revenueddebt service) is comparatively low due to its low tax burden.

Figure 1.1: Guatemala - Growth Rates of GDP and GDP per capita

8.0%

6.0%

5 4.0%

05 5 2.0% 111 f 0.0%

-2.0%

-4.0%

-6.0%

-e GDP --c GDP per capita -A- TREND

Source: Central

1.16 The economic policies followed by Guatemala have not been distinctively different than those'of other Latin American countries. In the fifties and sixties the country followed an 5 import substitution regime and institutional policies (such as the ceilings on interest rates, the fixing of the exchange rate, the use of development banks to channel credit, and large infrastructure investments) similar to other countries. The economy also benefited at the time from an expansion of the agricultural frontier and growing agricultural exports. As in other countries, however, these policies and developments did not prove to be sustainable. They also generated rigidities that had to be addressed through reforms.

1.17 There have been some important sectoral changes over time. As can be seen in Table 1.2, the structure of the Guatemalan economy has changed over the last fifty years. In the fifties and sixties, manufacturing’ benefited from the import substitution policies, while more recently those sectors directly affected by policy reforms (such as power and telecommunications) have grown the most. As in most ofLatin America, agriculture has seen a consistent reduction in the contribution of agriculture to GDP, as other sectors grow faster. The decline also reflects the adverse trend in the terms of trade for agriculture. However, agriculture remains an important sector for the economy. Another important development was the relative decline in housing and construction, which suggest that the country’s infrastructure may not be keeping pace with its growing population, especially with the volume of its trade and production.

Table 1.2: Guatemala - GDP Structure - 1951-2002 51-55 56-60 61-65 66-70 71-75 76-80 81-85 86-90 91-95 96-00 01-02

Agriculture 32.5 29.9 30.0 27.9 27.8 26.6 25.2 25.7 25.3 23.7 22.7 Mines 0.2 0.2 0.2 0.1 0.1 0.2 0.3 0.3 0.3 0.5 0.5 Manufacturing 12.2 12.5 13.3 15.2 15.8 15.9 16.0 15.6 14.7 13.8 13.1 Commerce 26.4 26.5 26.5 28.1 28.4 27.8 26.5 24.8 24.2 24.7 24.7 Construction 2.6 3.1 2.0 1.8 1.7 2.9 2.9 1.9 2.1 2.3 2.0 Electricity, oil and water 0.5 0.6 0.8 1.1 1.3 1.6 1.7 2.2 2.7 3.3 4.0 Transport, storage and communications 3.8 5.0 5.1 5.3 5.9 6.5 6.8 7.3 8.3 8.9 9.9 Bank 1.3 1.5 2.1 2.3 2.4 2.9 3.6 3.8 4.3 5.1 5.1 Housing 8.6 8.7 8.6 7.6 6.4 4.8 4.8 5.2 4.9 4.7 4.6 Public Administration 6.2 5.8 5.5 4.8 4.7 5.0 5.8 6.8 7.3 7.4 7.6 Private services 5.8 6.1 6.0 5.7 5.6 6.0 6.2 6.2 6.0 5.8 5.7

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Central Bank ofGuatemala.

1.18 The most striking change over the last two decades has been the declining share of the manufacturing sector and the rapid growth of the service sector (see Table 1.3). The latter houses the most dynamic segments of the Guatemalan economy in recent years, including commerce, transport, utilities, banking, and services, a result of greater demand for these sectors and lower relative prices for the agricultural and manufacturing goods. Clearly deregulation and liberalization of the financial, power and telecommunications sector have resulted in large expansions in those areas of the economy. In Guatemala, these changes are often used as demonstration that the traditional agroexport model of development is exhausted, and that the secondary sector (manufacturing and construction) is not generating sufficient

’ The manufacturing data may be understated since it does not include the maquilas, some processed food products and artisan production. Similarly, the data for agriculture does contain some non-traditional agricultural exports that have been growing rapidly in the last decade. 6 growth to absorb the labor being shed by declining sectors and the new entrants to the labor force, as employment in the expanding sectors has been slower than the fall in employment in the declining sectors.

Table 1.3: Guatemala - GDP growth rates 51-55 56-60 61-65 66-70 71-75 76-80 81-85 86-90 91-95 96-00 01-02

PIB 2.3 5.4 5.3 5.8 5.6 5.7 (1.1) 2.9 4.3 4.0 2.1

Agriculture 0.8 5.1 4.3 4.8 6.2 3.2 (0.3) 2.9 2.8 2.8 1.3 Mines 8.4 0.8 (0.2) 1.9 5.6 49.5 (13.7) 6.1 13.5 11.7 3.5 Manufacturing 2.5 6.7 7.1 8.2 4.8 7.8 (2.1) 1.9 2.9 2.5 0.8 Commerce 2.5 4.8 6.6 6.6 4.6 5.3 (2.3) 1.8 4.9 3.8 2.5 Construction 0.5 1.5 4.8 3.1 9.7 20.0 (11.2) 6.6 6.5 2.4 (2.0) Electricity, oil and water 7.9 8.6 14.0 9.0 8.8 10.4 1.2 8.5 8.3 11.0 1.6 Transport, storage and communications 9.2 4.9 8.6 5.9 9.0 7.4 (0.5) 5.2 6.0 6.3 6.0 Bank 4.0 12.5 12.0 5.3 7.8 12.0 0.3 5.2 7.8 5.6 (0.8) Housing 3.5 5.9 2.7 3.0 2.1 0.5 2.3 2.0 2.8 3.4 2.7 Public Administration 1.3 7.9 0.9 6.0 6.4 6.7 3.3 4.4 5.5 4.5 3.2 Private services 4.7 5.2 4.3 4.5 7.3 6.2 (0.1) 2.1 3.2 3.6 3.7 Source: Central Bank of Guatemala.

1.19 With the change of its structure, the Guatemalan economy today is more diversified than before and less volatile. As shown in Table 1.4, the coefficient ofvariation of output per capita for Guatemala has declined in the nineties as compared to earlier periods. This decline has been dramatic compared to earlier decades (a reduction of two thirds in the size of the variations). This more stable pattern of economic growth reflects in part the dampening effects of economic diversification, since new emerging sectors are more stable than agriculture, where price and volume fluctuations were much more pronounced. The reduced volatility was also probably aided by improved macro management and the adoption of policies that have dampened the impact of external shocks on the economy (such as the liberalization of interest rates and the floating of the exchange rate). As also shown in Table 1.4, the variability of the Guatemalan economy has been lower than the average for the Region. In fact, during the nineties the output volatility measure for Guatemala was one- fourth the size ofthe average for Latin America.

Growth rate of Volatility of Persistenceof trend output per output per capita output per capita' capita LAC GTM LAC GTM LAC GTM

1960-1970 2.36 2.58 1.62 1.23 0.0354 -0.1643

1971-1980 2.08 2.47 2.71 1.59 0.1641 0.1855

1981-1990 -0.02 -1.33 2.85 0.2316 0.6504 1991-1999 1.76 1.35 1 1.65 0.47 0.2725 -0.1364 Source: Loayza, Fajnzylber y Calderon (2002). - Indicates how persistent are deviations from trend in retuming to equilibrium. 7

1.20 The consequences ofthe diversification of Guatemala’s economy provide an indication of factors that may be important for future growth. The diversification has created a demand for a better quality labor force, placed growing pressures on the country’s infrastructure, and generated the need to modernize its policy and institutional framework. As some sectors of the economy have grown and become more dynamic (such as the trade and financial sectors, communications, electricity, and commerce), new needs have arisen. Increased international trade, for example, has required larger and better port facilities, improved roads, a more efficient customs administration. Other sectors to function efficiently and be competitive, such as the maquilas or the financial sector, must have a reliable source ofpower and require better telecommunications systems. Even parts of the agricultural sector that have performed well, such as non-traditional products, require improved marketing tools and information, easy access to transport, a system of quality standards and ability to adapt to changing market demands.

1.2 1 Despite strong progress in reducing tariffs and other trade liberalization measures, Guatemala has made only limited progress in expanding trade in the 1990s. Trade flows (exports plus imports as percentage of GDP) increased from 39 percent in 1991 to 50 percent in 2001. However, most of this progress can only be attributed to import growth as total exports have remained practically stagnant for the last ten years at around 19 percent of GDP, despite positive developments in exports of maquila and other nontraditional products. Most significantly, Guatemala still exhibits the lowest share oftrade in GDP in Central America and is well below the LAC region’s 2001 average of 80 percent.

1.22 The stagnant export ratio of recent years is the result of significant differences in the trends of three different sectors. The first is the booming maquila sector, with net exports increasing steadily since 1990, as a result of US trade preferences and the success of the free trade zone regimes in attracting FDL2 In current U.S. dollars, maquila exports grew at an average annual rate of 18 percent between 1992 and 2002. The second is the group of traditional export products (i.e., coffee, bananas, sugar and cardamom) which have seen trade volumes fall steadily during the 1990s, as a consequence of slow demand growth and low commodity prices. The third is nontraditional exports (e.g., flowers, seasonal vegetables, fruits, and organic crops), which grew dynamically until 2000 but have stagnated since then in part due to the recent recession in the US and Latin Ameri~a.~As a result of these trends, Guatemala’s exports have diversified substantially in the 1990s, despite little progress in terms oftheir overall value with respect to GDP.

’ The Guatemala maquila sector is distinguished in Central America for its emphasis on delivering the so called “full package”, in which textile producers are responsible for most phases of production. This ability fosters a competitive edge based on service delivery rather than solely on low labor costs. Growth of non traditional agricultural exports has been attributed to (i)agricultural policies to promote diversification; (ii) access to long-term financing from public credit programs that allowed small and medium farmers participate in this process and (iii)investments in infrastructure (irrigation, roads and electricity). In addition, private organizations and trade associations like the Non Traditional Products Exporters’ Association (AGEXPRONT), played a catalytic role in promoting nontraditional exports (Monge and Gonzalez Vega, 2003). 8

C. Policy Reforms

1.23 With the return of democracy, the country embarked on a period ofreforms. In the last fifteen years, the country has gone through three important phases of reforms. First, the trade regime began to be liberalized in the mid to the late eighties, especially in the context of the Central American Common Market. The policies included a reduction in import tariffs, to an average of 24% in 1987 (with the top rate reduced from 300 to 100 percent). Exchange rate control and many non-tariff barriers were eliminated. Incentives, in the form of exemption from some taxes and import duties were extended to re-exporters (maquilas) and for non- traditional agricultural exporters. During the time, the country also joined the GATT and entered into several trade agreements and received the benefits of the Caribbean Basin Initiative. These policies were accelerated fbrther in the nineties, when export taxes were removed, the unweighted tariff was hrther reduced to less than 10 percent along with the dispersion in rates, and the exchange rate was allowed to float. The policies marked a substantial opening of the economy, moving it away from the import substitution model and accelerated the process of integration into global markets. The result has been a sharp increase in imports, from 13% of GDP in 1985 to 27% in 2002, as well as in exports, which went from 11% to 17% in the same period. The real growth rate of trade values exceeded 6.5% a year, with similar increases in volume. (See Chapter V for a detailed description of Guatemala’s recent Trade Policy.)

1.24 The second key set of reforms occurred in the financial sector. Beginning in the early nineties the authorities liberalized interest rates, allowed the exchange rate to float, and later improved the independence ofthe Central Bank, standardized reserve requirements, eliminated compulsory lending, introduced a deposit guarantee, and improved supervision. The policies also facilitated the entry of new banks and other financial intermediaries, along with the merger and acquisition of banks. The result of these reforms was to broaden and deepen the markets, and to expand the services available. Measured by the level of a broad money to GDP, as proxy for the level of market deepening, this share rose from 21% during the crisis year of 1990 to 30% in 2000. The same occurred with credit from the banking system to the private sector, which rose by a similar share of GDP. Still many reforms remained unfinished, particularly the strengthening of consolidated supervision, the controls on connected lending, the consolidation of financial conglomerates, and regulation of off-shore operations. Substantial reforms in the financial sector’s legal framework was introduced in 2002. (See Chapter I11 for a detailed description ofrecent developments in Guatemala’s Financial Sector). 1.25 The third wave of reforms took place in the late nineties with the greater participation of the private sector in infrastructure and with measures to modernize regulation. The reforms included: privatization ofthe power and telecommunications companies; granting concessions for the operation ofthe railroad network and the construction of a major road; the management contract for the mail service roads; and the liberalization of foreign investment, among others. 9

Figure 1.2: Guatemala - GDP Growth Rates

Source: Central Bank of Guatemala.

D. Recent Developments

1.26 Despite the end of the conflict and the implementation of economic reforms during the 1990s, growth rates have fallen since 1998 and have not surpassed the rate of population growth since 2001 (figure 1.2). As a result, many of the targets set in the Peace Accords have not been met and the poverty rate may have increased after 2001. Poverty levels had fallen from 62 to 56 percent from 1989 to 2000 (World Bank, 2002), a period during which the output per capita grew at an average rate of 1.3% a year.

1.27 The recent deceleration of the economy is due to both external and internal factors. On the external front, the economy has been hit by a strong decline in the price of coffee and a decline in demand for key exports, related to the slowdown in the world economy of 2000- 2002. In the internal front, tight monetary conditions between 1998 and 2000 cooled aggregate demand, while the intense conflict between the previous administration and significant segments of the private sector led to a deterioration of governance and the investment climate and reduced the attractiveness to both foreign and domestic investment. In addition, Guatemala failed to continue with the reforms begun in the late eighties, and lagged in the important goal of strengthening public institutions.

1.28 Several external shocks have affected Guatemala in recent years. The terms of trade were negatively affected, mainly through a drastic and long-lived collapse in the world price of coffee. Export revenues from this crop fell from close to $580 million in 1999 to $268 million in 2002. The impact was most acute on the income of a large number of laborers and coffee farmers since approximately 600.000 Guatemalans were directly and indirectly involved in the coffee business prior to the price decline. In addition, recession in the U.S. and other trading partners in the 2000-2002 resulted in falling demand for Guatemalan exports, affecting most directly exports of non-traditional maquila products. Aside from depressing exports, the downswing in the U.S. economy may have also influenced economic activity in Guatemala 10 through investor sentiment and other channels, as traditionally swings in the U.S. economy have tended to reverberate loudly in manufacturing activity (see Figure 1.3). Additionally, in 2003, the sharp increase in the price of petroleum added $240 million to the import bill for fuels and lubricants (an increase of 60%) and contributed to a weakening in the terms oftrade.

Figure 1.3: Growth Rates of GDP USA and IMAE* - Quarterly

+GDP-USA IMAE * IMAE: Indice Mensual de Actividad Econ6mica. Source: National of Labor Statistics and Central Bank of Guatemala

1.29 Despite external shocks and the stagnation in the level ofper capita income since 2000, the level of consumption has continued to increase. Real consumption grew at an annual rate of over 3.5% as compared to 2.3 % for GDP between 2000-2002. This is a result of compensatory external inflows that have managed to ameliorate the potential impact of these shocks. These inflows can be grouped into two types. The first are the remittances which have grown rapidly in the last few years, from $407m in 1997 to $2,10Om in 2003 (8.5% of GDP) and which tend to flow to middle sectors in rural settings, providing a safety net to many families. The second are the growing external financing flows to the private sector, which account for most ofthe large and growing current account deficits (Figure 1.4). In contrast, the public sector has actually reduced its savings-investment gap.

1.30 Adjustment to external shocks has been facilitated by the availability of external financing. The large current account imbalances have been financed mostly by private financial flows through the banking sector and other informal flows (including possibly revenues from the trafficking ofillicit good^).^

It should be noted that the workers remittances, which now under better reporting account for 7% of GDP is not a source of financing of the current account. Remittances are “above the line” and are a source of financing for the trade deficit. It

s ff

"" tI

6 ft 12

Figure 1.5: Real Interest Rate (Lending)

16.0% 1--* 7

14.0%

12.0%

10.0%

8.0%

6.0%

Source: World Bank with information from Central Bank of Guatemala.

1.33 Negative shocks on the external and internal front suggest that the economy has been growing below its capacity since 2001. Netting out the effect of business cycle variations, growth rates over the past three years have been as much as 1% per annum below capacity (see Figure 1.6).

Figure 1.6: Growth Trends in Guatemala, 1991-2003

6.0% 1

~-Growth HP50 I I ,. , I . ,. , HPIOO

----I '___~_ HP400 'I 1.0% +--- 0.0% -I I I , I , Ill

Note: HP series from filtering with Hodrick Prescott filter with various values of the lambda coefficient (50, 100,400). Source: World Bank.

E. Near Term Outlook and Macroeconomic Concerns

1.34 The gradual dissipation of the negative external shocks of recent years, led by the pickup in the U.S. demand for Guatemalan imports has set the stage for a gradual recovery of growth in 2004 and 2005. The economy should rebound as external demand from trading partners firms up (esp. from the U.S.), and as investment is attracted by the prospects of the 13 upcoming free trade agreement with the U.S. and further progress in Central American integration efforts5 In addition, the recovery of the economy which was evidenced in 2004 reflected the improvement in business sentiment that has been associated with the Berger administration, its prompt actions to maintain sound macroeconomic and fiscal management and early measures to advance in reforms to strengthen the competitiveness ofthe Guatemalan economy. Monetary policy has also been conducive to a recovery, as interest rates have remained generally low since 2001. While rising prices due in great part to high fuel costs have prompted some upward interest rate adjustments in early 2004, this is likely a sign of improving economic conditions and unlikely to affect the expected recovery.

1.35 Nevertheless, the rebound is unlikely to be sustained and of the magnitude needed to meet Peace Accord targets unless measures are taken to revert the declining trend in structural growth. The effect of the improvement in the external environment and the dissipation of external shocks will increase the usage of capacity, and may return the economy to its structural growth rate.6 However, the structural rate now seems to be lower than in the 1990s and displays a worrisome declining trend.' To revert this trend and obtain higher growth rates that can be sustained over the medium run will require a resumption of reforms that can address key bottlenecks to growth in Guatemala.

1.36 The greatest future macroeconomic challenge for Guatemala lies in improving its internationally low tax ratio. The Peace Accords set a target of 12% of GDP to be reached by 2002, a significant increase from the level that existed at the time of the Accords (7.9%). Unfortunately, progress was slower than expected and, after some setbacks, the ratio reached 10.3% of GDP at end 2004. With a relatively low level of tax receipts, authorities are hamstrung in at least two critical levels. First, fiscal policy has few degrees of freedom to accommodate shocks and provide countercyclical stimulus when needed. Although the debt burden appears seemingly low in international comparisons, the low tax take limits the capacity to service debts much beyond its current level. Second, the dearth of public funds limits investments in key growth-enhancing investments, including those that are critical to boost the pace of economic and social progress.

1.37 Movements in the level of the real exchange rate have generated concerns and some debate in Guatemala in recent years. Remittances and financial flows seem to be the underlying causes of the moderate appreciation trend of 1999 to 2002, and the depreciation in

Background work for the CEM showed that both the price of oil and the exchange rate are also factors that could play a role in the short run. Both of these variables could work to restrain the expected recovery, since the price of oil is close to historical highs and the real exchange rate has appreciated in the last few years (Somensatto, 2004). There is some evidence that even a rapid return to historical growth rates may be difficult. A simple statistical analysis commissioned for this CEM reveals that there may be no stable long term trend for economic growth in Guatemala. There have been periods of high economic growth as well as extended periods of low growth rates. This reveals that changes in economic growth may be permanent and have cumulative effects. Once growth slows, it may remains below a certain average level for a while, not necessarily recovering automatically (Somensatto, 2004). A slowdown of four or more years is unprecedentedin Guatemala and an admittedly unusual length of time for an economy to grow so slow. If past pattems are any indication, it could reflect a slow down with deeper structural characteristics that would only be reversed by measures to accelerate reforms and policies to promote higher growth (Somensatto, 2004). 14

2003 (see Figure 1.7). The overall appreciation, moderate by regional standards, has been blamed for the stagnation in exports (and associated trade deficit) and has generated calls among exporters for an active devaluation policy. However, since real exchange rate movements seem driven by market conditions, it is unlikely that monetary policies can be used effectively to reverse this trend, other than temporarily. Attempts to engineer a real drop in the value of the Quetzal via nominal devaluation are likely to be dissipated by higher domestic inflation. In order to improve the fundamental competitiveness of exports, more promising actions should focus on bolstering the access of Guatemalan goods to international markets (as expected with the upcoming CAFTA and other trade agreements), as well as on improving the competitiveness position of exporters by facilitating wider access to new technologies, higher investments in infrastructure that lower transportation and logistics costs, improved information flows about external market opportunities and access to financing.

Figure 1.7: Central America, Real Effective Exchange Rates (1997=100) I i

60.0 c , 8- 4 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Costa Rica --- -Guatemala ~ ~ - 1--.. - _.Panama I Source: World Bank with data from Central Banks.

I11 - Accounting for the Sources of Economic Growth

1.38 Given the disappointing performance ofthe Guatemalan economy since the signing of the Peace Accords, the key issue remains how to achieve higher growth rates in the future. To deal with this challenge, it is important to identify the key factors that could contribute to increase the rate ofeconomic growth. While the amount ofpotential areas ofaction is too large in a country like Guatemala, the challenge is in determining which are the most essential priorities. This section obtains some insights from a simple growth accounting exercise and

* Policies to stem the effect ofremittances on the real exchange rate would likely require for the public sector to compensate for greater private sector spending by increasing the savings rate of the public sector, a difficult stance in a country in which there are pressing needs in social and infrastructure spending. 15 then uses results from a cross-country econometric growth model to identify priority reform areas.’

A. Growth Accounting

1.39 To analyze the sources of Guatemala’s poor growth performance, it is useful to decompose GDP growth into the growth of factor input quantities and the growth of total factor productivity (TFPG) using the traditional growth accounting framework. The methodology identifies the three basic factors that explain growth: labor use, physical capital and total factor productivity (Le., the unexplained residual after deducting the labor and capital contribution). The growth of the latter is usually the result of the continuous process of factor reallocation to activities of higher productivity as well as adoption of new technologies or of better “quality” factors that boost production without commensurate increases in factor use. Historical experience demonstrates that sustained medium and long run economic growth has been always associated with substantial expansion in total factor productivity.

Table 1.5: Guatemala - Contributions to Output Growth

output Components of Growth growth Labor 1 Capital I TFPG Period Simple Solow Residual Method Guatemala 4.02% 1.82% 1.54% 0.67% 1961-2000 1961-70 5.50% 1.85% 1.90% 1.75% 1971-80 5.65% 1.70% 2.22% 1.73% 1981-90 0.87% 1.61% 0.70% -1.43% 1991-00 4.06% 2.10% 1.32% 0.64% Solow Residual after Accounting for Human Capital 1961-70 5.50% 2.13% 1.90% 1.47% 1971-80 5.65% 3.05% 2.22% 0.39% 1981-90 0.87% 2.08% 0.70% -1.90% 1991-00 4.06% 2.63% 1.32% 0.11% Solow Residual after Controlling for Capital Utilization 1961-70 __ -- _- -- 1971-80 5.65% -- -- -_ 1981-90 0.87% 0.79% 0.55% -0.46%

1961-70 5.08% 1.67% 1.94% 1.53% 1971-80 4.69% 1.80% 2.36% 0.68% 198 1-90 1.21% 1.62% 0.98% -1.31% 1991-00 3.54% 1.54% 1.32% 0.70%

1.40 Growth accounting results reveal that the growth of labor, first, and capital, second, explain the bulk ofthe growth of GDP for most ofthe last four decades (Table 1.5). However,

This approach contrasts with the more common method often used in Guatemala, which is to identify those sectors that could be the “motors” of economic growth, such as tourism, textiles, etc. Experience demonstrates that it is difficult to identify ex-ante successful sectors and design policies to support them. 16 the changes in output growth over different decades are mostly due to changes in TFPG and to swings in the (declining) contribution of capital after the 1970s.'' While Guatemala has followed broadly the swings in growth ofthe rest of Latin America, its distinguishing trait has been an above average labor contribution, mainly due to the surge in labor use in the 1990s. By contrast, the contribution of capital to growth has been lower than the regional average. As in the rest of the region, TFPG was negative in the 1980s and rebounded only modestly in the 1990s." 1.4 1 The growth accounting exercise suggests that explanations for Guatemala's poor growth performance are related to low TFPG as well as a disappointing pace of capital accumulation. In regional comparisons, Guatemala's low rate of TFPG in the 1990's (0.64%) is the key difference with economies with the best growth performance in Central America during the same decade such as Costa Rica (1.98%) and Panama (1.12%), and other LAC countries like Dominica Republic (2.91%) and Chile (2.81%) (Figure 1.8). The prominent role played by a low level of TFPG in the evolution of overall growth of Guatemala suggests a number ofpossible factors that may be impeding growth: factor reallocation processes may not be hnctioning appropriately, the economic policy framework may not be guiding resource allocation decisions properly, the pace of adoption of improved technologies has been insufficient, or the quality of factors has not improved significantly through time. All of these potential problems highlight the need for public policy to spur productivity growth in Guatemala.

Figure 1.8: Growth Performance in Central America - 1960-2000

i 6000.0 iw 1 25000.0 1n n- 0 $4000.0 m,3 .e P 'P3000.0 G: 5 m2000.0 L nz I- - -c 1000.0 e Honduras NI 0.0

Source: Own calculations with data from Loayza, Fajnzylber & Calder6n (2002). loNote that data to properly capture the total active labor force is not available in Guatemala. Recent studies have used the either the working age population, 15-64 years of age (Loayza, Fajnzylber, and Calderon 2002), which does not measure those actually working, or the social security institute's measure of the economically active population in the formal sector (Loening, 2002) which only accounts for approximately one quarter of the total labor force. The exercise presented uses the former assumption. I' Chapter 2 will show that a significant share of TFPG in Guatemala since 1960 captures the improvements in quality in the human capital input. Background work for this CEM derived a series for labor force cohorts adjusted by educational attainment weighted by rates of return (Loening, 2002). 17

f 1.9: I 18

1.44 The decline in public capital formation in recent years has been the result of a sharp fiscal adjustment. The rate ofpublic investment to GDP averaged in excess of 5 percent in the late seventies and early eighties, but fell abruptly to around 2.5 percent of GDP for most of the eighties and nineties. Following the short surge in public investment that took place after the signing ofthe Peace Accords, the share ofpublic investment to GDP dropped once again from 5.5% in 1999 to 3.4% in 2002. This retrenchment, greatly due to the tight fiscal stance of recent years, indicates that fiscal objectives may be exerting undesirable repercussions on the longer term growth potential ofGuatemala.

B. The Factors Contributing to Growth

1.45 Annex A analyses the main determinants of growth in Guatemala, based on the findings of a cross-country study by Loayza, Fajnzylber and Calder6n (2002), which relates economic growth to twelve key explanatory variables for 78 countries. These variables include five indicators related to structural policies and institutional development (comprising education attainment levels, financial depth, trade openness, government consumption and public infrastructure), four indicators related to macroeconomic policy outcomes (comprising measures of price stability, output volatility, real exchange rate over-valuation and the prevalence of systemic banking crises), and three exogenous variables (including the terms of trade and period specific-shifts).

1.46 The model predicts well growth developments in the 1990s in Guatemala. Table 1.6 presents predicted and actual changes in average per capita GDP growth observed in the 1990s vis-a-vis the 1980s. Guatemala averaged 1.4 percent annual per capita growth in the 1990s, 3.1 percent per annum above the (negative) rate registered in the 1980s. This is somewhat above the change predicted by the model’s results, which is 2.44 percent. The discrepancy must be mostly attributed to the effect ofthe end ofthe internal armed conflict which generated higher growth than expected by measurable indicators. The model indicates that improvements in structural policy settings (Le, educational levels, infrastructure, the opening of the economy, and a reduction in the burden of g~vemment)’~accounted for a bit more than one third of the overall improvement in growth in the nineties, with the financial depth and governance indicators exerting a negative effect in this period.

l4 The variable used to measure the burden of the government in the economy is the level of govemment consumption to GDP and its results should be interpreted with care in the case of Guatemala. This variable is comparatively low for Guatemala and declined even further after the intemal armed conflict, suggesting an “improvement” with a positive impact on growth. However, studies have shown that below a certain level, govemment consumption can also have a negative effect on growth, particularly when the govemment is not able to provide minimum conditions for a proper growth environment 19

Table 1.6: Changes in Per Capita Growth: Central America 1990s vs 1980s

~ Dominican Guatemala Costa Rica El Salvador Honduras Sicaragua Republic

Actual growth 1.43% 3.80% 0.04% 0.84% 4.40% 3.44% Predicted growth 2.44% 1.13% 0.73% 0.82% 1.84% 2.42%

Transitional convergence 0.29% 0.06% 0.26% 0.13% 0.72% -0.05% Initial GDP per capita 0.29% 0.06% 0.26% 0.13% 0.72% -0.05%

Cyclical reversion 0.24% 0.55% 1.43% 0.29% -3.56% -1.36% Output gap 0.24% 0.55% 1.43% 0.29% -3.56% -1.36%

Structural policies and institutions 1.29% 1.08% 1.90% 0.60% 2.22% 1.03% Education 0.46% 0.15% 0.34% -0.08% 0.46% -0.06% Financial -0.06% -0.10% 0.10% -0.16% 0.21% -0.12% 0 pe nne s s 0.21% 0.41% 0.37% -0.07% 0.30% 0.16% Government 0.43% 0.26% 0.66% 0.43% 1 .OO% 0.39% Infraestructure 0.41% 0.35% 0.63% 0.58% 0.37% 0.70% Governance -0.16% 0.00% -0.20% -0.11% -0.12% -0.05%

Stabilization policies 0.38% 0.33% 0.50% 0.17% 0.77% 0.44% Inflation 0.01% 0.04% 0.04% -0.05% 0.84% 0.05% Volatility 0.25% 0.02% 0.31% -0.08% 0.31% 0.27% Overvaluation 0.11% -0.02% -0.13% 0.30% 0.67% 0.12% Crises 0.00% 0.29% 0.29% 0.00% -1.06% 0.00%

External condition 0.25% 0.17% 0.10% 0.13% -0.12% 0.82% Terms of trade 0.25% 0.17% 0.10% 0.13% -0.12% 0.82%

Source: Loayza, Fajnzylber & Calderon (2002).

1.47 The robustness of the model can also be analyzed by the power to explain the variations in growth rate during five-year periods that do not include the armed-conflict. As shown in Table 1.7, these results are more variable. For the comparison period between the early nineties vis-a-vis the late eighties, the model predicted well; an improvement in growth of 1.18% compared to an actual difference of 1.15%. By contrast, in the late nineties (1996- 1999) the average growth rate actually declined by 0.25% with respect to the early 1990s, while the model anticipated an increase of 1.49%. Factors not well captured by the model, such as lagging and poorly implemented reforms, weak institutions and declining investment rates, are probably responsible for this behavior (for details, see Annex A).

Structural policies Stabilization policies Education Financial Trade Gov. Burd. Infrast. Sum Inflat. Volat. Overv. Crisis Sum

Guatemala 0 23 -006 0 19 0 38 024 0.98 003 0 17 000 000 0.20 Costa Rica 0 19 -007 023 0 30 021 0.86 -001 -041 000 058 0.15 El Salvador 0 07 007 030 0 51 038 1.33 004 -030 -006 058 0.26 Honduras -0 10 -0 18 -0 05 0 45 031 0.43 -005 -009 030 000 0.17 Nicaragua 0 43 094 021 108 0 19 2.85 093 062 102 -1 16 1.42 20

1.48 The model can be used to predict the future level of growth in individual countries on the basis of forecasts of the future values of the explanatory variables. In making these forecasts, two scenarios have been considered: the “Passive” scenario assumes that the explanatory variables continue to evolve over the next decade according to past historical trend~.’~The “Active” scenario assumes the implementation of policy reforms that raise all the explanatory variables to the top 25th percentile of their distribution in Latin America and the Caribbean.

1.49 Under the “Passive” scenario, assuming the country continues to pursue policy changes at the rate of the 1990s, Guatemala’s per capita growth would improve slightly, from 1.43 percent per annum in the 1990s to 2.2 percent on average for the 2000-2010 period (Table 1.8). If this rate were sustained, it could be expected to reduce extreme poverty by about 7 percentage points between 2000 and 2015, and poverty by about 11 points (Table 1.9). While this rate would be just slightly below the 2.4 percent required to meet the Millennium Development Goal of cutting extreme poverty by half by 2015, the improvements under the “Passive” scenario for Guatemala compare unfavorably with what would be achieved by other Central American and LAC countries following historical trends, a reflection of the faster rate ofreform elsewhere during the 1990s.

]Average LAC 13.64 11.44 12.20 1 1-0.48 11.78 10.90 Source: Annex A. Notes: The figures for Central America exclude Guatemala and include Panama. Across each row, the difference in the projected a;erage growth rate in 2001-10 and the actual average growth rate in the 1990s (31d column on the right) is equal to the sum of impacts due to changes in extemal factors, structural variables and macroeconomic variables.

1.50 Under an “active” scenario, Guatemala would be able to boost its growth rate significantly by accelerating the pace of key reforms. Under the scenario which advances the explanatory variables to the top 25th percentile of the LAC distribution, Guatemala’s average annual per capita GDP growth would increase to 5.04 percent in the 2000-10 period. If this rate were sustained, it would mean that extreme poverty would be reduced by more than half between 2000 and 20 15 (over 10 percentage points), and poverty would decline to about 3 1%.

Most of the gain in growth under the two reform scenarios is due to improvements in the structural variables, rather than improvements in macroeconomic management. This outcome

l5 Forecasts are obtained using univariate regressions for most variables, with linear and quadratic trends as explanatory variables. 21 indicates that, on balance, Guatemala’s macroeconomic management has been fairly stable in the 1990s. By contrast, the country lags significantly behind its Central and Latin American neighbors in structural measures. l6

Table 1.9: Guatemala -- Projected Evolution of Poverty Headcount Indicators Under Alternative Growth Assumptions

1.O% I 12.2% I 50.8% 2.0% I 9.0% 1 45.0% 3.0% I 6.6% 1 39.9% I 4.0% I 4.8% I 35.3% 5.0% I 3.4% 1 31.1% Source: Calculations based on a gross elasticity of poverty reduction to growth of -0.99 for total poverty and -2.44 for extreme poverty. These elasticity estimates are from the ENCOVI 2000, Instituto Nacional de Estadistica - Guatemala. See also World Bank, Poverty in Guatemala, 2002.

1.5 1 Focusing on the impact from each individual determinant of growth (Table 1. IO), most of the growth increase in Guatemala under the “Active” scenario would emerge from the expansions of education and public infrastructure. l7 The improvement in education policies explain a boost in annual per capita growth of 1.67% per year, while those in public infrastructure yield a 1.09% improvement. In third and fourth place, with somewhat less potential impact, are the impact ofgreater financial depth (0.49%) and trade openness (0.36%). Of the nine policy related determinants of growth considered in this analysis, catching up in these four areas would yield the greatest growth payoff in the future and, thus, merit priority attention.

l6For instance, in education, the indicator used by Loayza et al (2002) is the percentage of children enrolled in secondary level of school, for which Guatemala’s level in the 1990s (7.8%) is below the Central American average (17.7%) and the LAC average (21.7%). In public infrastructure, in the variable used (the number of phone lines per 1000 inhabitants), Guatemala has 28 phone lines, significantly below the Central American average (63) and that for LAC (84). ” Improvements in the government burden would not yield growth gains, according to the projections. This result, however, is somewhat biased since it is based on the use of Government consumption relative to GDP as a proxy for government burden. Given the low level of tax revenues in Guatemala and the relative small role of its Government in consumption, an improvement in this variable would require a reduction in consumption from already a very low level compared to other countries. If regulatory burden or governance measures had been used the impact might have been different. 22

Table 1.10: The Key Determinants of Growth in Guatemala: 2000-2010

Impact of Active versus Passive Scenario Guatemala 1.23 0.49 0.24 0.01 0.68 2.69 -0.12 0.00 0.27 0.00 0.15 Average CA 0.88 0.37 0.09 0.35 0.67 2.36 0.03 0.31 0.14 0.00 0.47 Average LAC 0.48 0.44 0.31 0.31 0.55 2.09 0.03 0.43 0.06 0.07 0.59

1.52 There is a case to be made for also considering two variables that were not explicitly included in the model’s forecasts (i.e., governance and innovation) in which additional efforts may yield a substantial growth impact. For the case of governance, measures were excluded from the final formulation of the model because they turned out to be statistically insignificant when included among the other variables. However, the governance indexes exhibited among the highest positive bivariate correlations with per capita GDP growth among all the explanatory variables used in the regression analyses. Loayza et a1 (2002) interpret this finding to mean that the effect of governance on economic growth works through the actual economic policies that governments implement. Furthermore, Guatemala consistently ranks among the worst performers in international governance comparisons. For example, Transparency International’s Corruption Perceptions Index ranks Guatemala well below the regional and global averages (Figure 1.9). Since this is an area in which Guatemala also lags far behind, the adjustment of governance indicators toward regional or global standards could have a potentially large pay-off in terms ofgrowth.

1.53 Another area that may yield a growth impact in Guatemala is that related to innovation. As was pointed out earlier, sustained growth in total factor productivity is critical for growth and for capital accumulation. A key aspect of productivity growth is keeping a sound system for the free flow of ideas, import of new technologies and adaptation to Guatemalan conditions, including local innovations. As mentioned above, this is a requirement for an economy to maintain dynamic productivity and overall growth. In a recent World Bank study on this subject, it was demonstrated that Latin American countries lag far behind world leaders in Asia and elsewhere in terms of investments in R&D as well as in institutional mechanisms to foster collaboration between the private sector, universities and public institutions (World Bank, 2002). 23

Figure 1.10: Corruption Perception Index in Latin America and the Caribbean, 2000-2002

Score

8.0

7.0

6.0

5.0

40

30

2.0

1.o

2000 m2001 02002 1

Source: Transparency Intemational.

1.54 Finally, it should be noted that in the analysis that follows of growth determinants, education is analyzed jointly with health and nutrition related issues, on the basis that in the Guatemalan context, advances in the former are unlikely to be productive without progress in the latter.

IV. Growth, Poverty Reduction and Inequality

1.55 Higher economic growth is critical to improve the welfare of the Guatemalan population and to reduce poverty. Recent historical experience from a wide sample of developing countries indicates that the bulk of achievements in poverty reduction in the 1980s and 1990s have been the result of growth in average incomes." The countries that have experienced the greatest reduction in poverty over this period are those that have experienced high rates of sustained economic growth. In fact, despite the recent and sometimes heated debate on the virtues of economic growth for poverty reduction, there is plenty of evidence suggesting that the poor typically do share from rising aggregate income and do suffer from economic contractions.

1.56 Faster poverty reduction, however, can be achieved if the country also takes steps to address its high inequality levels. The impact that growth has on poverty depends on two main

~ 18 A recent study by Kraay (2004) decomposed changes in poverty in a large sample of developing countries during the 1980s and 1990s and found that in the medium to long run, most of the variation in changes in poverty can be attributed to growth in average incomes. Most of the remainder of the variation is due to poverty-reducing patterns of growth in relative incomes, rather than differences in the sensitivity of poverty to growth in average incomes. 24 factors. The first is the change in income distribution that occurs in parallel to the growth process. In this regard, growth accompanied by progressive distributional improvement will have a higher impact on poverty reduction than growth alone. The second factor is the initial distribution of income. Even if growth is not accompanied by changes in the distribution of relative incomes, high inequality is a break for poverty reduction in the sense that the impact that a one percent growth rates has on poverty is higher in more equal societies. While this CEM focuses on how to boost overall economic growth in Guatemala, a brief discussion ofthe important issue of inequality and its interaction with growth and poverty in included below.

1.57 In order to reduce extreme poverty by half between 2000 and 2015 and thus accomplish the first of the Millenium Development Goals, Guatemala needs to improve its economic growth, change the degree of income inequality, or a mix of both. Table 1.11 displays alternative scenarios required for the accomplishment of this goal. l9 The scenarios simulate changes in poverty relying on best estimates of poverty elasticities and initial distribution. Relying exclusively on growth, Scenario 1 indicates that an average per capita growth rate of 2.4% would be required between 2004 and 2015. Relying exclusively on changes in distribution, Scenario 2 would require a reduction in the Gini coefficient from 0.57 to 0.42 in the same period.20 For illustration purposes, Scenario 3 is an arbitrary mix that indicates that the MDG could be met by a lower growth rate than Scenario 1 (only 1.5% per annum) with a drop in the Gini to only 0.54. Scenario 4 in Table 1.11 assumes that Guatemala starts out in 2004 with a 20 percent lower degree ofinequality, to illustrate the dramatic impact of high initial inequality on poverty. In fact the results of scenario 4 suggest that with this "virtual" inequality, relying on growth alone the country would need to achieve an average rate of 1.9% per year to meet the MDG, well below the 2.4 percent estimated in the first scenario. This feature is not exclusive of the Guatemala data but an established empirical fact: the lower the level of initial inequality, the higher the growth-poverty payoff.21

Table 1.11: Growth and distribution growth rates required to reduce poverty by half between 2000 and 2015 (average rate of change, 2004-2015) Per Capita Gini coef. Scenario Growth Rate Growth Rate Gini in 2015* 1 - Growth alone 2.4 0.0 0.57 2 - Distribution alone 0.0 -2.5 0.42 3 - Growth and distribution 1.5 -0.5 0.54 4 - Growth alone* * 1.9 0.0 --- Scenarios constructed with growth to extreme poverty elasticity of -2.44 and Gini to extreme poverty elasticity of 2.40. *Assumes that initial income Gini in 2004 is 0.57, the figure from 2000 survey. ** Initial Gini of 0.46 and higher distribution to poverty elasticity than in the base scenario by 0.8, according to simulated elasticities in Lopez (2003).

l9 The Table uses the growth and inequality elasticities derived from a log normal distribution by Lopez (2003). *' Note that changes in inequality of the size implied by Scenario 2 are unprecedented, as Gini coefficients tend to change only slowly through time according to historical evidence from many countries. 21 This is analytically established by Bourguignon (2002) for the case of log normal distributions and empirically supported in Chapter 1 of World Bank (2003) and in Ravallion (2004). 25

Box 1.1: Measures to improve income distribution in Latin America

To address the deep historical roots ofinequality in Latin America, and the powerful contemporary economic, political and social mechanisms that sustain it, a recent World Bank report highlights the following four broad areas for action by governments and civil society groups to build coalitions to break this destructive pattern:

Build more open political and social institutions, that allow the poor and historically subordinate groups, such as Afro-descendants and indigenous people, to gain a greater share ofagency, voice and power in society. Ensure that economic institutions and policies seek greater equity, through sound macroeconomic management and equitable, efficient crisis resolution institutions, that avoid the large regressive redistributions that occur during crises, and that allow for saving in good times to enhance access by the poor to social safety nets in bad times. Increase access by the poor to high-quality public services, especially education, health, water and electricity, as well as access to farmland and the rural services the poor need to make it productive. Protect and enforce the property rights of the urban poor. Reform income transfer programs so that they reach the poorest families, including use ofmeasures that are conditional on keeping children in school and attending health services, so as to improve their lifelong income-earning capacity.

Source: David de Ferranti, Guillermo Perry, Francisco H. G. Ferreira, Michael Walton, “Inequality in Latin America and the Caribbean: Breaking with History?”, World Bank, 2004.

1.58 The above discussion suggests that inequality is a hindering factor to poverty reduction and that measures to address its reduction merit attention in Guatemala. While raising growth is essential to reducing poverty over the coming years, improving distribution may also be a worthwhile goal in order to facilitate poverty reduction goals. Reducing inequality would have several potential benefits. First, it would lower poverty directly by lifting the income of families initially below the poverty line. Second, it would improve the growth-poverty payoff. Third, it may enhance growth itself by reducing latent social conflicts and removing some structural obstacles that impede future economic expansion (e.g., credit market failures that obstruct the poor from exploiting opportunities for human and capital investments).22 However, redistributive policies need to be weighed carefully against their costs, as some may also affect incentives for investment and growth. A recent World Bank study analyzed different areas of measures designed to improve income distribution in Latin America, highlighting the importance of careful country-specific analysis and the need for strong leadership and broad coalitions for reform (see Box 1.1).

22 The arguments that have been used to justify a potential negative effect of initial inequality on future growth are summarized in Chapter 1 of World Bank (2003). 26

1.59 Aside from growth and inequality, a final key factor that affects the rate of poverty reduction is the pattern of growth. While poverty reduction results have been shown to be greatly determined by the growth in average incomes and the constraints imposed by initial distribution, significant heterogeneity of results across countries with similar growth and inequality combinations demonstrates that the pattern of growth also matters for poverty reduction. Broad based growth patterns (also known as “pro-poor” patterns)23 favor processes that facilitate the effective participation of the poor in the e~onomy.~~Althoughthere is still significant debate and research attention on the most important elements of a policy agenda that would make growth more broad based, policies that are most likely to ensure that Guatemala’s future pattern of growth does not bypass the poor should, at a minimum, include:

0 Maintain macroeconomic stability and prevent financial sector crises, in order to improve growth and avoid crises that usually affect the poor disproportionally; 0 Improve public finances, which requires increasing the tax ratio to, at a minimum, the Peace Accords target of 12% of GDP. New revenues should be used in great part to finance a progressive public spending agenda that generates growth and lessens inequality, with a special focus on building the assets of the poor and providing some insurance to the most vulnerable. Key elements of such a progressive public spending agenda are: o Investments in education with priority to improve quality and access to pre- primary and primary; o Expanded access to a health care package, including actions to reduce malnutrition; o Investments in key infrastructure (e.g., roads, water, sanitation), with emphasis in rural areas where the population is predominantly poor. o Improved targeting ofpublic subsidies (e.g., electricity). o Removing key structural impediments to access markets and growth opportunities by the poor, including facilitating access to credit by micro, small and medium enterprises.

1.60 Given that the majority of the Guatemalan poor reside in the rural setting, many of the key policies and investments will need to focus on rural areas. Given the need for specialized analysis ofthe issues related to rural development, the Bank is addressing this topic through its study “Identifying Drivers of Sustainable Rural Growth and Poverty Reduction in Central America,” which focuses at length on the situation in Guatemala. A preview of the main findings and recommendations coming out ofthis study appears in Box 1.2.

23 “Pro-poor” growth has been defined as growth that reduces poverty (Ravallion, 2004). A more strict definition proposed by some observers requires that growth reduce poverty and also improve the distribution of income (Klasen, 2003). The latter definition is more strict and would exclude, for example, the experience of and India in the 1980s and 1990s, countries in which growth has reduced poverty significantly but in the context of non-poor segments seeing faster income gains than those ofthe poor. 24 There is evidence that in Guatemala infrastructure is strongly correlated with the profitability of microenterprises, and that access to electricity, water and telephony have large significant influences on the incomes of the poor (Le. expansion of these services to undeserved populations is likely to lead to equalizing income increases). 27

1.61 Clearly, it should be acknowledged that the most difficult challenge facing Guatemalans today is to put in practice this growth agenda within the limits of a prudent fiscal stance. For this purpose, Guatemalans should place the highest priority in reaching the needed consensus that will make it possible to raise public revenues to levels necessary to meet these pressing challenges.

V. Conclusion

1.62 After displaying some dynamism earlier in the 1990s, the Guatemalan economy has seen its growth rate decline since 1998 and stagnate below population growth since 2001. The deceleration of the economy can be attributed to both external (e.g., coffee prices and world recession) and internal factors (e.g., poor business climate, lagging reform efforts). This stagnation, along with other elements, has meant that many of the targets set in the Peace Accords have not been met and that poverty may have increased after 2001. There is a critical need to boost growth urgently in Guatemala in order to demonstrate that a peaceful environment can yield tangible benefits to the population and to provide opportunities to a relatively young population.

1.63 In the short run, growth should improve as the negative external shocks ofrecent years dissipate and business sentiment improves due to the recent change in administration. However, it is unlikely that the recovery will be sustained or of the magnitude required for a robust pace ofpoverty reduction and the meeting of other Peace Accords targets. To revert the declining trend in structural growth, a resumption of reform efforts is required, including adopting measures that will expand tax revenues to at least the 12% of GDP envisioned in the Accords and attract significant private financing for key infrastructure. Broad-based growth and improved competitiveness are likely to require significant public expenditures for which the country is currently ill prepared. This should be done in the context of preserving sound fiscal management and continued implementation of financial sector reforms that will prevent costly emergencies in the future.

1.64 For the longer term, Guatemala needs to improve its total factor productivity growth and capital investment, as these have been responsible for the mediocre historical growth performance. Improvements in human capital have accelerated in the 1990s, and need to be sustained in the future. Public policies to spur factor productivity are most critical, as staying on historic trends would leave the economy on a slow growth path that is unlikely to meet the needs of the large amount of Guatemalans under the poverty line.

1.65 Since attempts to address all pending areas of reform simultaneously would disperse efforts and weaken results, the challenge facing the authorities is being able to focus its attention and resources on carrying out the most high-yielding actions. A methodology to prioritize among areas found that the greatest impact on growth would materialize over the next decade if efforts are focused on improving human capital, public infrastructure, financial market depth, and trade openness, areas in which Guatemala has been lagging significantly behind in its development vis-a-vis other Latin American countries and the rest of the world. ' In addition, governance and innovation policies are two hrther areas in which Guatemala has performed poorly and may prove critical for consolidating sustained growth. 28

1.66 While growth has been demonstrated to exert a significant impact on poverty reduction in Guatemala and elsewhere, its impact is conditioned by initial levels of inequality. This CEM focuses on boosting growth, but it acknowledges that improvements in inequality would speed up the rate of poverty reduction. In addition, the poverty reduction payoff ofgrowth is likely to improve if it is broad-based, for which it is essential to raise public funds that can be dedicated to human capital and infrastructure investments that facilitate the participation of the poor in the growth process.

1.67 The remaining chapters of this report provide an in depth look at the six key areas prioritized to improve growth prospects over the coming years in Guatemala. Chapter I1 focuses on education and, more broadly, the important role of human capital development for growth, including health and nutritional status. Chapter I11 identifies weaknesses and makes recommendations to improve the investment climate, broadly understood, including governance, access to infrastructure, and to finance. Chapter IV analyzes the importance of technology and innovation for productivity growth. Finally, Chapter V looks at trade openness and the catalytic role that the recently negotiated free trade agreement with the U.S. (known as CAFTA) could have on the Guatemalan economy.

1.68 Ultimately, the greatest challenge facing Guatemala today is to put in practice a streamlined growth agenda while maintaining a prudent fiscal stance. This inevitably requires undertaking simultaneously actions to raise significant new tax revenues, improve the efficiency ofthe public sector, attract private financing for large infrastructure needs and focus additional public expenditures in those areas that are most critical to obtain broad-based growth, such as social sector investments in education and health and the extension of coverage of basic services (water and sanitation, transport, etc.) to disadvantaged populations. Since these critical actions are likely to require significant resources, as indicated above, Guatemalans should place high priority in reaching the needed consensus that will make it possible to raise public revenues to levels necessary to meet these pressing challenges. 29

Box 1.2: Drivers of Rural Growth in Guatemala

How can public investments be designed to improve rural growth prospects while ensuring improvements among disadvantaged groups? What strategies will create conditions for self-sustaining rural growth? These questions are being addressed in Guatemala by a World Bank study, "Identifying Drivers of Sustainable Rural Growth and Poverty Reduction in Central America."

"Drivers" of sustainable rural growth and poverty reduction are identified by focusing on household assets (broadly defined to include natural, physical, financial, human, social, political, institutional and location assets) and their combinations necessary to take advantage of economic opportunities. This approach is based on the understanding that the quantity, quality and productivity of household assets determine the potential for long-term inclusive growth and poverty reduction.

The Guatemala case study highlights the following major findings and recommendations: 1. Regional differences. Rural Guatemala is characterized by stark regional differences in conditions affecting economic growth and poverty reduction. The highly differentiated spatial distribution of economic potential implies a need for differentiated rural development strategies according to an area's specific assets, markets and institutions.

2. Asset Complementarities. Investments in "single-assets'' such as agricultural technology require complementary investments for impacts to be broad based. For example, investments in education, roads and other infrastructure related to access to markets intensify the positive effects of agriculture and other land-based productive investments which by themselves have limited growth and poverty reduction impact. To exploit asset complementarities requires moving from untargeted, single sector approaches to multi-sectoral investments which can increase a household's portfolio of assets--according to the specific needs of different regions and households.

3. Productive investments. To improve growth prospects, productive investments should be targeted toward higher economic potential areas and designed to exploit local comparative advantages. In better-endowed areas, productive investments should be paired with targeted efforts to help disadvantaged households participate in the economy. Other less advantaged areas should also receive specific investments based on existing assets and growth potential.

4. Poverty rates and density. The high degree of overlap between high poverty rates and high poverty densities in areas such as the Westem Altiplano, which is also an area of high potential, means that investments there should reach significant proportions of the country's rural poor.

5. Engines of rural growth. Agriculture must be an engine of rural growth, but non-agricultural activities are also important livelihood strategies that require support, and are often linked. Populations that migrate, and the financial support from the Diaspora can be channeled to support important productive activities in rural areas. To be an engine of growth, the agricultural sector needs to become even more efficient and competitive in domestic and intemational markets, and diversify into higher value products. However, for many poor rural households, achieving improved food security by increasing productivity of basic grains is a necessary first step.

6. Agricultural potential. The study identified areas of higher agricultural potential, access to major infrastructure and population density in which agriculture should form an integral part of the rural growth strategy. High reliance of rural households on agricultural and related income means that any strategy will have to build upon the economic base created by agriculture. Recent performance ofthe agricultural sector has not been very robust, and negatively impacted by Hurricane Mitch, recurrent , collapsing coffee prices. However, several bright spots exist, including non-traditional exports.

7. Constraints to agricultural growth. Agricultural growth is constrained by unequal access to land, degradation of natural resources such as water and soil fertility, absence oftechnologies for productivity enhancements, weak institutions for technical assistance and broader information about markets, and others. In areas with agro-economic potential such as the Westem Altiplano, contiguous small landholding sizes limit the potential for the creation of larger economically viable landholdings. Altematively, policy should be designed to intensify production on small landholdings through soil fertility enhancements, imgation, higher-yielding varieties, etc.

8. Natural resource management. For agricultural and non-agricultural rural growth there is a need for better natural resourcc management that integrates management of land, forest and water resources in a more equitable and sustainable manner. This will requirc an appropriate legal and institutional framework (including enforcement) that recognizes the rights of indigenous groups to natura resources, and improves their access to these assets.

9. Indigenous groups. Strategies are needed to confront historical exclusion of indigenous population and redress their low levels of productive assets and retums on assets. Indigenous rural households have mean levels of consumption about 30 percent lower than the non-indigenous, controlling for levels of education, language ability, land holding and other productive assets. This finding provides strong evidence of exclusion from public services and economic opportunities. Some efforts, such as strengthening property rights and providing more transparent rules of access to institutions, will benefit all, but will have a particularly strong impact on excluded groups. Chapter 11. Human Capital and Growth in Guatemala

I.Introduction

2.1 Human capital - especially education - has long been considered a key determinant of growth performance. Growth accounting results reported in Chapter Irevealed that the growth of labor (both quantity and quality) is responsible for much of GDP growth since the 1960s in Guatemala. Admittedly, in the 1990s and in particular since the 1996 Peace Accords, the country has made significant progress in increasing the education and health levels of its population. However, despite this progress, education and health indicators remain among the lowest in the region. Public expenditures in these areas remain extremely low and the country still faces tremendous challenges in developing the human capital of its population. In some areas improvements have slipped and progress in areas such as chronic malnutrition appear to have stagnated - or possibly even increased - in the last few years. In other areas chronic historical problems persist leading to highly unequal levels of human capital between the rich and poor and between ladino and indigenous communities.

2.2 The analysis presented in Chapter Iindicates not only that education has been a key determinant of growth in Guatemala in recent years but that it is likely to be the most powerful determinant of growth over the next ten years. While health indicators were not included explicitly in the cross-country growth exercise, there is also some evidence that points to an important relationship between health status and growth, particularly for lower income countries in which nutrition levels can become a hindering factor to productivity. What do these findings imply for a national strategy for human capital development to promote growth in Guatemala?

2.3 This chapter examines the state of human capital development in Guatemala, the role of human capital in promoting economic growth in the country, and the key avenues for fostering growth through human capital investments in the medium term. The evidence presented in this chapter makes clear that strengthening the human capital ofits people will be a critical element of Guatemala’s efforts to increase economic productivity and growth in the coming years - and to taking advantage of emerging economic opportunities in the regional and global economy. Indeed, new empirical evidence from Guatemala indicates that both education and health status are key determinants of productivity, incomes, and growth in the country. The evidence also suggests that persistent inequalities in human capital hinder the country’s growth performance.

2.4 This chapter is organized as follows: The following section reviews recent developments in the education and health sectors, and highlights ongoing challenges related to developing the human capital of the Guatemalan population. Section 3 examines the structure and recent evolution of Guatemala’s labor force and discusses what it might imply for future human capital investments in the country. Section 4 discusses the now considerable body of empirical evidence - both from within and outside of Guatemala - that demonstrates the link between education and health status and the country’s growth performance. In light of the evidence, Section 5 outlines a strategy for investment in human capital in Guatemala that will help to enhance the country’s growth perfonnance in 31 the medium term. The chapter ends with a brief discussion of financing needs for a growth-focused human development strategy in Guatemala.

11. The State of Human Capital Development in Guatemala

Education

2.5 Education featured prominently in Guatemala’s Peace Accords in 1996, and the transformation of the country’s education system is an important component of the agreement. The Accords on Identity and Rights of Indigenous Peoples and on Socioeconomic Aspects and Agrarian Situation specifically address education issues. These accords establish that education is a means to transmit and develop values and knowledge within a multilingual and multicultural society; thus the curricula must integrate the diverse cultures and languages of the country. They also establish that education and training are key factors to achieve equity, national unity, economic progress and international competitiveness.

2.6 Structure of the Education Sector. The Ministry is responsible for regulating, directing, planning, supervising and evaluating the country’s education system at the initial, pre-primary, primary and secondary levels, including both public and private, and formal and non-formal education. In this role, the Ministry of Education recognizes five formal education levels and corresponding target ages:

Initial Education, from birth to age 6, Pre-Primary, for ages 5 and 6, Primary, for ages 7 to 12, Secondary, for ages 13 to 20 0 University.

2.7 Primary education and the levels below it have no pre-requisites, whereas secondary and University are open only to students that have completed the previous level. Secondary education is divided into two sub-programs. Basic Secondary (grades 7 to 9) follows primary school and is similarly characterized by a common curriculum that must be taken by all students. Diversified Secondary (grades 10 to 13) have 4 tracks: (i)general (seen as preparation for University), (ii)teacher, (iii)technical, and (iv) commercial. There is a great deal of heterogeneity across programs in this overwhelmingly private sector level, with “tracks” lasting anywhere from two to four years.

2.8 In addition to the formal education system, there is a non-formal system of education that is directed to those who remain outside the reach of the formal school system. It includes initial education programs, accelerated pre-primary, extra-mural, and literacy training that are implemented by a combination of governmental and non- governmental actors. A variety ofskills- and job-related training courses are also available for those in the job market, through firms, private sector training institutes, NGOs and through public sector training institutes, such as INTECAP, Guatemala’s Technical Institute for Training and Productivity. 32

2.9 Recent Developments in the Education Sector. Guatemala has made important progress in increasing primary school enrollments since the Peace Accords. By 2001, net primary enrollment rates were at 88 percent, up from around 70 percent where they had hovered during the first half of the 1990s (Figure 2.1). Guatemala has also experienced moderate increases in secondary school enrollments in the past few years, both at the basic and diversified secondary levels. For example, net enrollment rates at the basic secondary level rose to 28 percent in 2001, after having spent much of the 1990s at around 20 percent (Figure 2.1); net enrollment rates at the diversified secondary level increased to 16 percent, up from 11 percent at the time ofthe Peace Accords.

Figure 2.1: Net Enrollment Rates in Primary, Basic Secondary, and Diversified Secondary Education, 1991-2001

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

+Primary +Basic Secondary Diversified Secondary

Source: CIEN

2.10 School completion rates also increased somewhat during the 1990s - although they started at very low levels and remain unacceptably low. In 2000, primary completion rates were 37 percent, up from 32 percent in 1989 (Figure 2.2). Secondary completion rates were 27 and 18 percent in 2000 at the basic and diversified secondary levels respectively, up from roughly 15 and 12 percent in 1989. Recent improvements in schooling outcomes have also translated into slightly higher education attainment levels for Guatemalans over the last decade. In 2000, the average Guatemalan, age 25-65, had just over 1 year more of education, than the average Guatemalan in that age bracket in 1989.27

’’ CIEN; Figure 9. f 1 f 31 34

Table 2.1: International Comparison of Key Education Indicators

El Costa Latin Guatemala Nicaragua Honduras Salvador Rica America Indicator Average years of 3.5 4.6 4.8 5.2 6.0 7.2 6.0 schooling (2000) Net primary school 84 81 88 81 91 103 97 enrollment (2000-01) b' Net secondary school 26 36 ... 39 49 60 64 enrollment (2000-01) b'

Adult illiteracy (2002) " 30.1 32.9 23.8 20.3 4.2 8.3 10.5 Source: Adapted from Loening (2003); a/ World Development ... dicators, World Bank (200 , bi UNDP (2003b). ci World Bank (2003).

Figure 2.3: Primary Completion Rates for Non-IDA Countries in Latin America and the Caribbean (2001/2002)

120 T

100 T

0 h---- 0 1000 2000 3000 4000 5000 6000 7000 Per Capita GDP- (US$)

Source: di Gropello, Dubey, and Winkler 2003 35

Figure 2.4: Basic Secondary Completion Rates for Non-IDA Countries in Latin America and the Caribbean

rl

Source: di Gropello, Dubey, and Winkler (2003)

2.12 Education quality also remains low in Guatemala. A 2002 study analyzed mathematics and reading achievement of 5,825 third and fourth grade students, using a combination of national and international (UNESCO-OREALC) test instruments. The study found that on average mastery of both mathematics and reading was low. The average percentage of correct answers among 3‘d graders was only 38 percent for math and 51 percent for reading. While still low, fourth grade test scores were somewhat higher; the average percentage correct for math was 46 percent, while the average percentage correct for reading was 58 percent. Although both 3‘d and 4th grade students tended to score better in Spanish than in math, the standard deviation in reading scores was higher. This reflected the large proportion of native indigenous language speakers among the test takers.

2.13 Comparing education quality in Guatemala with education quality in other countries is complicated by the fact that Guatemala has not administered internationally comparable achievement tests, such as the TIMSS, TIMSS-R, or the fill UNESCO- OREALC Laboratory Test. In such international tests, Latin America as a region tends to score relatively poorly with respect to mathematics achievement, given per capita income levels (di Gropello, Dubey, and Winkler 2003). And available evidence suggests that school quality in Guatemala is still low by regional standards. One available indicator of quality is based on survey data of employers’ perception of school quality.29 Employers gave high ratings for public school quality and science and math education to OECD countries, East Asian countries, and several Latin American and Caribbean countries, such

29 “Guatemala: A Study on Student Achievement In Primary Education,” World Bank, 2003. 36 as Trinidad and Tobago, Uruguay, Jamaica, and Costa Rica. But they gave low scores to Guatemala (along with Honduras, Ecuador, Paraguay, and Bolivia; see Figure 2.5, below).30

Figure 2.5: School Quality According to Employers’ Appraisal, 2000

0 1 2 3 4 5 6 7 Public school quality

Key: 1= Lags far behind most other countries, 7 = Among the best in the world Source: Global Competitiveness Report 2001-2002, Harvard University, reported in di Gropello, Dubey, and Winkler 2003

2.14 Guatemala’s education outcomes also tend to be highly unequal, between rich and poor as well as across other socio-economic categories. While net primary enrollment rates were 93 percent among the richest 20 percent (quintile) of the population in 2000, they were only 60 percent among the poorest quintile (Figure 2.6). Although not as large, important primary enrollment gaps exist across rural and urban areas (10 percentage points), across ladino and indigenous groups (9 percentage points), and across females and males (5 percentage points). Combined basic and secondary net enrollment rates were 62 percent amon the richest quintile in 2000, but only 3 percent among the poorest quintile (Figure 2.7). 39 As at the primary level, important gaps exist as well between rural and urban areas (34 percentage points) and between ladino and indigenous groups (18 percentage points).

30 These findings are consistent with a recent study of returns to education in the US of male immigrants from different countries (Bratsberg and Terrell 2002). This study finds that returns to education in the US labor market are relatively low for Central American immigrants, in general, and specifically for immigrants from Guatemala. These, like the findings of the employers’ survey noted in the text, are suggestive of relatively low education quality within the Guatemalan education system. 31 It is worth noting that in Guatemala even disaggregations at the quintile level can hide important inequalities in income and human capital outcomes within each quintile. 37

Figure 2.6:Primary Net Enrollment Rates, by Quintile, 2000

100% 93% 90% -..--- 82% 80%

70% a, d 2 60% 6 6 50% s 40% t 30%

20%

10%

0% Lowest Quintile Second Quintile Third Quintile Fourth Quintile Highest Quintile

Source: Edwards, 2002

Figure 2.7: Secondary Net Enrollment Rates, by Quintile, 2000

70%

60%

c B 5 40% -E 30% w c 2 20%

10%

0% Lowest Second Third Quintile Fourth Highest Quintile Quintile Quintile Quintile

Source: Edwards, 2002. 38

2.15 Primary and secondary school completion rates also remain highly unequal. While primary completion rates among children in the richest quintile are surprisingly low (68 percent) reflecting an overall deficiency in the education system, they are nearly 7 times higher than completion rates of around 10 percent among children in the poorest quintile (Figure 2.8). Basic and diversified secondary school completion rates among children in the richest quintile are 63 and 46 percent, respectively, whereas secondary school completion rates - for both basic and diversified - are almost zero among children in the poorest quintile.

Figure 2.8: Primary and Secondary School Completion Rates, by Income Quintile

0 -K 70% 60% .-0 5 50% 5 40% 0 5 30% M E 'g 20% B 10% 6 Y 0% 0L 2 Qunitle 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 8

Source: CIEN

2.16 Continuing inequalities in school enrollment and completion rates have translated into differential rates of increase in average years of schooling by income group, as well. Thus, while average years of schooling increased between 1989 and 2000 for all income groups, gains have been greater among higher income groups (Figure 2.9). The sole exception has been that in the richest quintile. Those households began the period with dramatically higher levels of education than those in the other quintiles, however; and it is possible that the slower growth in years of schooling among the fifth quintile reflects the fact that the wealthy - unconstrained by financial considerations - had already largely attained their desired levels of schooling by the start ofthe period.32

32 Average years of schooling increased more in urban than in rural areas between 1989 and 2000, and more among Ladino than indigenous groups 39

Figure 2:9: Additional Years of Schooling, 1989-2000 (population 25-65 years of age)

I

I 1

i 0.8

0.4

0

~ Overall Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5 %- ______Source: CIEN

2.17 Beyond general education, a number of Guatemalans participate in skills or job- related training to build their human capital. Skills training is offered through a number of different sources, including on-the-job, through private training firms, NGOs, and through a variety of government training institutions, including INTECAP (Guatemala’s Technical Institute for Training and Productivity). The vast majority of skills training is undertaken on the job or within private sector training institutes. As in the case of general education, the opportunity to benefit from skills training goes largely to the non-poor in Guatemalan society (Box 1). However, as will be discussed in Chapter IV, it is important to ensure that those who want to improve their human capital through skills training have access to good quality institutions and that funds administered by INTECAP be administered in an efficient manner that ensure their full benefit and proper aligning with the skills needs of employers.

2.18 In summary, in spite of gains since the signing of the Peace Accords in 1996, the education sector in Guatemala continues to faces many challenges. Primary school completion rates are alarmingly low despite increased enrollments, as is primary school quality. Moreover, access to education remains highly unequal in Guatemala. While these are serious challenges for the education sector, it is more important to recognize that the absence of a well educated workforce poses an important constraint to Guatemala’s efforts to increase economic growth. 40

Box 2.1: On-the-Job and Skills Training Programs in Guatemala

According to the 2000 ENCOVI data, nearly 9 percent of economically active individuals over the age of 12 had received job training in the previous 12 months. Several things stand out with respect to on-the-job and skills training programs in Guatemala.

Over two-thirds ofjob training takes place in urban areas. About 47 percent of all trainings is done by firms or private sector training institutes. This compares with roughly 26 percent that isprovided by the public sector (including by INTECAP, Guatemala’s Technical Institute for Training and Productivity), 8 percent by NGOs and 18 percent by “other” training providers. Survey respondents report taking a wide variety of types ofjob or skills trainings. The largest single category of courses reported in 2000 focused on computers and informatics (9.2%), followed by human relations (5.7%), and sales (4.1%). As with other types of education, participation in job training is very much skewed towards the non- poor. About 62 percent of all those who reported receiving training in the ENCOVI survey came from the wealthiest quintile, whereas 4 percent came from the poorest quintile (Box Figure I).

Box Figure 10: Attendance in Job Training Courses, by Quintile, 2000 n

I

20 0.y

100%

0 0% 1 2 3 4 5

Source: CIEN, using the ENCOVI 2000 survey data.

Health and Nutrition

2.19 The health and nutritional status are also core inputs into determinants of the quality of human capital since they are critical to people’s well being and their economic productivity. As with education, the 1996 Peace Accords included significant 41 commitments to improve health and health care services in Guatemala. These included commitments to improving key health outcomes (e.g., reducing infant and maternal mortality, eradicating measles) by improving curative and preventative health care services, expanding coverage to underserved populations in rural areas and in indigenous communities, and promoting greater non-governmental and community participation in health care delivery.

2.20 Structure ofthe Health Sector. The Ministry of Public Health and Social Action (MSPAS) and the Guatemalan Social Security Institute (IGSS) are the two main public entities responsible for health care provision in Guatemala. The MSPAS, which plays the largest role, is responsible for providing curative and preventative care for the entire population. The MSPAS also plays a key policy role, with a constitutional mandate to define sectoral policies and coordinate other actors in the sector. The IGSS provides health services, as well as retirement benefits, to eligible formal sector workers and their families. Private providers including both, traditional health practitioners and modem providers, as well as NGOs (both national and international) also play active roles in the health sector.

2.21 Given relatively low eligibility to health services under IGSS (about 17 percent of the population are enrolled and not all of those receive health benefits) most Guatemalans rely on other types of providers for their health care - via the MSPAS (either through direct service provision or services contracted through NGOs) or via private (either traditional and modern) providers. In 1997, in an attempt to improve health service access the Government piloted, and subsequently scaled up, an innovative program that contracts NGOs to provide basic health and nutrition services to Guatemalans living in predominantly rural and marginalized communities. The Programa de Extensi6n de Cobertura (PEC), is targeted at low-income communities with no access to the Ministry’s health centers. This program has grown rapidly, and currently contracts over 100 NGOs to provide services to approximately 3,600,000 people, about 30 percent of the Guatemalan population.

2.22 Recent Developments in Health and Nutrition. Despite some improvements in health indicators over the last 15 years, Guatemala continues to face a number of critical challenges in terms of raising the health status of its population. For example, even though infant mortality has declined significantly - from 73 to 39 deaths per 1,000 live births between 1987 and 2002 - infant mortality rates remain high by regional standards (Table 2).33 The country’s maternal mortality ratio stands at 153 matemal deaths per 100,000 live births, using the RAMOS~~method of measurement, significantly higher than the rate in Honduras (108). As with education, basic health status differs in important ways across the country’s different socio-economic groups. For example, maternal mortality ratios are

33 A recent cross-country study found that the infant mortality rate is 5.7 percent higher than would be expected, given Guatemala’s level of per capita income (Todd and Hicks 2003).

34 RAMOS estimates (Reproductive Age Mortality Studies) are considered the “gold standard” for estimating matemal mortality in countries where vital registration data are poor. These studies review all deaths in the country of women of reproductive age to identify the cause of death. Even in countries with good death registration and good attribution of cause of death (such as the United States), estimates of matemal mortality drawn from vital statistics probably underestimate the real ratio by 50%. 42 roughly three times higher among indigenous groups than in ladino populations according to the RAMOS results.

Table 2.2: International Comparison of Key Health Indicators

Latin Guatemala Nicaragua Honduras El Salvador Costa Rica Mexico America

Infant mortality (per 1000 39 36 31 33 9 24 28 births) iv Matemal Mortality Ratio (per 153 N.A. 108 N.A. N.A. N.A. 100,000 live births) b’ Chronic Malnutrition 49 20 33 23 6 ...... (percent “stunted”, height for age) at birth 65.5 68.7 66.1 70.1 77.6 73.6 70.7 (years) ’

Source: ai2002 estimate for Guatemala; all others 2001 ,World Bank (2003); bi RAMOS estimates: for Guatemala, MSPAS, 2003; for Honduras, Melendez JH, Ochoa JC, Villanueva Y., 1999; c/ Most recent source and year: Guatemala, ENSMI 2002; Nicaragua, DHS 2001; El Salvador, FESAL 1998; Honduras, CDC 2001; Costa Rica, yy? 1996; for Honduras malnutrition among 12-59 month olds; all others, among 3-59 month olds; d 2002 estimates, World Bank (2003).

2.23 The country’s greatest health challenge is chronic malnutrition or “stunting”. Stunting (as measured by height-for-age) affected 49 percent of children under five in 2002, according to ENSMI data (Table 2.2; Box 2.2). This is the highest incidence of stunting in Latin America and the Caribbean, and its prevalence rate is comparable with countries with much lower levels of per capita income such as Nepal, Pakistan, and Rwanda. While chronic malnutrition declined in Guatemala between 1987 and 1995, stunting rates have stagnated since 1995; indeed, the ENSMI data indicate that rates have increased in the past few years (Figure 2.1 l).35

35 It is unclear whether the changes between 1995 and 2002 are statistically significant. 43

Chronic Malnutrition, or Underweight Acute malnutrition, or Survey Year (ENSMI) Stunting (HeightiAge) (WeightiAge) wasting (WeightiHeight) 1987 57.9 33.5 __ 1995 49.7 26.6 3.3 1998198 46.4 24.2 2.5 2002 49.3 22.7 1.6

I Stunting is such a serious health and development concem because growth retardation in the first two years of life is associated with greater risk of illness and mortality in young children. For children who survive, il negatively impacts learning and school performance. Stunted children grow up to be adults who, on average perform less well at physical labor and are less productive economically. Moreover, stunted girls become mothers with higher risks of delivering underweight babies, therefore transmitting the impact of their owr malnutrition at an early age across generations. 44

Figure 2.11: Chronic Malnutrition in Children Under 5 Years of Age, 1987-2001

-

50 30%

10% sI

0 Yo 1987 1989 1991 1993 1995 1997 1999 2001

2.24 As with other key social indicators, national malnutrition figures conceal important differences in nutritional outcomes across Guatemala’s different socio-economic groups. For example, 56 percent of children under-5 were stunted in 2002 as compared with 37 percent in urban areas (ENSMI 2002). Differences were even greater across indigenous and ladino children; stunting affected 70 percent of indigenous children under five in 2002 compared to 37.5 percent of ladino children. Moreover, the poor bear a disproportionate burden of malnutrition. According to Demographic and Health Survey (DHS) data, 65 percent of children in the poorest quintile experienced chronic malnutrition in 1999, whereas only 5 percent ofthose in the richest quintile experienced stunting (Figure 2.12). 45

Figure 2.12: Chronic Malnutrition in Children Under 5, by Wealth Quintile, 1999

(Height-for-Age)

b) 70%

In

* 5 10% $ 0 0 Yo Lowest Second Third Quintile Fourth Highest Quintile Quintile Quintile Quintile

Source: ENSMI 1999.

2.25 Inequalities in the prevalence of stunting appear to be getting worse, because declines in stunting have been occurring more rapidly amongst higher income households (Figure 2.13). Indeed, between 1995 and 1999, the prevalence of chronic malnutrition actually increased slightly among the poorest 20 percent of Guatemalans while the prevalence rate dropped by nearly 40 percent among the richest families.

Figure 2.13: Changes in Prevalence of Chronic Malnutrition in Children Under 5, by Quintile, 1995-1999 (in percent) Source: Demographic and Health Surveys, 1995 and 1999.

40%

35% Q, 30% d 25% $ 20% m 6 15% m *P 10% E 5% 0 0%

-5% 46

111. Structure of the Labor Force

2.26 To better understand the contribution of human capital to economic performance in Guatemala, it is useful to understand the structure and evolution of the country’s labor force. In 2000, 66 percent ofthe Guatemalan population over the age of 15 participated in the labor force - 89 percent of men and 44 percent women over 15 (Vakis 2003). Labor force participation rates are fairly similar, on average, across urban and rural areas in 2000: 68 percent in urban areas versus 64 percent in rural areas. These similarities conceal considerable differences in the gender composition of the labor force in urban and rural areas, however. Male labor force participation is 7 percentage points higher in rural than urban areas (92 vs. 85 percent), whereas female participation rates are 19 percentage points lower in rural than in urban areas (36 vs. 55 percent).In terms of the sectoral composition of the labor force, agriculture still makes up the largest source of employment in Guatemala. According to the ENCOVI survey, 2000, about 36 percent of the total labor force and nearly half (47 percent) of all male workers reported working in the agricultural sector for their primary economic activity or job (Vakis 2003). In terms of total labor absorption, agriculture is followed by commerce (22 percent, primary job), “community services”, including public administration, defense, NGOs, and domestic services (16 percent), and manufacturing (14 percent). Whereas male workers are disproportionately represented in the agricultural sector for their primary job, women are more likely to be concentrated in commerce (including petty trading), community services, and manufacturing. 36

2.29 About 95 percent of the labor force worked in the private sector in 2000, while 5 percent worked in the public sector. In terms of occupations, approximately 38 percent of the labor force was self-employed in their primary economic activity. This includes small- scale farm activities, petty trading, and production of handicrafts in rural areas as well as one-person ventures that sell food, crafts, and low-end consumer products in urban areas. Another 32 percent of the labor force have “white collar” jobs in private enterprises, while 13 percent ofthe labor force was categorized as “blue collar” or day laborers (jornaleros). Fifteen percent ofthe labor force worked as unpaid (family) laborers.

2.30 The Guatemalan labor force continues to be concentrated in informal sector activities. In 2000, nearly two-thirds ofthe labor force (65 percent) worked in the informal sector for their primary activity (Vakis 2003).37 Informal sector enterprises are most widespread in rural areas, where 75 percent of the labor force is engaged in such activities. Nonetheless, more than half ofurban workers (55 percent) still work in the informal sector. In sum, the Guatemalan labor force continues to be characterized by a high degree of

36 According to ENCOVI, 2000, 14 percent of the labor force reported undertaking a secondary, as well as primary, occupation in the week prior to the survey. In rural areas, 16 percent reported a secondary activity, whereas 12 percent reported a secondary occupation in urban areas (Vakis 2003).

37 The informal sector is defined here largely in terms of the ‘size of the enterprise. Employees in private sector enterprises, day laborers, self-employed workers, and unpaid family laborers engaged in enterprises with 1-5 employees are considered to be working in the informal sector. Domestic employees are also defined as working in the informal sector (Vakis 2003). 47 informal sector activity, with an important share of the labor force, particularly men in rural areas, engaged in small-scale agricultural prod~ction.~~

2.31 This continuing concentration of workers in agriculture and the informal sector suggests that Guatemala is yet to have undergone a complete structural transformation in its economy -or a transformation in the economy’s demand for skilled labor. While some structural changes are evident in the long sweep since 1950 (discussed in more detail in Chapter I),the structure of output in the Guatemalan economy has changed relatively little from 1990 to 2001 (Figure 2.14). Agriculture as a proportion of GDP declined slightly during the period, from 25.9 to 22.3 percent of value-added. This decline in agricultural output as a share of GDP was accompanied by an increase in the share of services in the economy, from 54.3 to 58.4 percent. The share of industrial output in the economy essentially stagnated however, hovering at around 20 percent of GDP throughout the period. Manufacturing’s share of the economy actually declined over the period - from 15.1 to 12.9 percent ofGDP.

Figure 2.14: Structure of Output in Guatemala, 1990-2001

70.0%

60.0% n 50.0% rc 40.0% m 30.0% al 20.0% nE 10.0%

0.0%

i - I +Agriculture +Industry Manufacturing +Services

L Source: SIMA Database, World Bank

2.32 This lack of structural change in the economy is largely mirrored by a lack of structural change in the labor force over the same period (Figure 2.15). For example, the share of employment in agriculture declined a few percentage points between 1991 and 2000 - roughly in line with the decline in agriculture’s share in GDP. In spite ofthe small

38 It should be noted that households generally have multiple workers in the labor force, and that different working members of households often work in different activities, earning incomes in multiple sectors of the economy. The figures reported here summarize the activities of economically active individuals in the economy. 48

increase in the share of services in GDP, the share of employment in services barely changed over the period. At the same time, the share of employment in industry rose by a few percentage points, most likely in small and informal sector enterprises, given the declining share of manufacturing in GDP during the period.39

2.33 Guatemala’s combination of poor human capital outcomes and lack of structural change in the economy and labor force highlight a pair of complementary - and critical - challenges facing the country with respect to increasing its economic productivity and growth in the coming years. On one hand, poor nutrition and low education levels for a large proportion ofthe Guatemalan workforce result in a largely low-skill workforce which represents an important constraint to productivity and an impediment to growth. On the other hand, lack of dynamism in the economy provides weak incentives for individuals and families to invest in human capital, as they see relatively little opportunities for economic mobility or increased incomes.

Figure 2:15: Sectoral Structure of Employment, 1991 and 2000 r-- -- 100% 90% 80% 70% 60% ~ 0 Services 50% Industry

40% Agriculture~~ 30% 20% 10% 0% I 1991 2000 Source: SIMA Database, World Bank

2.34 Without concerted efforts on the part of the Government of Guatemala to increase the educational and nutritional status of all Guatemalans, the country may find itself with a persistently low-skill, low-productivity workforce, unprepared to take advantage of new economic opportunities that arise in the coming years (e.g., from the Central America Free Trade Agreement, CAFTA, among other things). At the same time, in the absence of large scale, strategic changes in economic policies (such as the broad improvements in the investment climate including governance, infrastructure services and access to finance

39 It is important to note that while the ENCOVI and the World Bank’s SIMA data sets provide slightly different numbers for the proportion of the Guatemalan labor force working in agriculture, the order of magnitude and overall qualitative pictures they provide are quite similar. 49 which are discussed in Chapter 111) Guatemala is unlikely to be able to utilize effectively any improvements in the population’s human capital that it does make.

IV. Human Capital, Productivity, and Growth in Guatemala

2.35 A large body of microeconomic and macroeconomic evidence - from Guatemala and elsewhere - shows strong links between human capital development, human productivity, and economic growth. This evidence indicates that to improve its growth performance, it will be important for Guatemala to improve the educational and nutritional status of its people, starting at the most basic levels. Future growth performance would also benefit from reducing the large existing inequalities in access to human capital in the country. This section reviews key findings on links between human capital development and economic growth. It focuses first on education, then on health and nutrition, and finally on the links between inequality in the accumulation ofhuman capital and growth.

Education

2.36 The accumulation of human capital through education has long been seen to be an important contributing factor to human productivity and income at the individual and household level and of economic growth at the macro level. A significant body of microeconomic and macroeconomic evidence from Guatemala, as well as other developing countries, confirms its importance.

2.37 Education and Economic Growth - Microeconomic Evidence. Extensive microeconomic evidence shows that education enhances the productivity of workers, whether on farms, or self-employed, for informal sector enterprises, or in large, formal sector firms. The impact of education on productivity comes through several main pathways: (1) through direct improvements in worker productivity; (2) through the increased ability of workers and enterprise managers to make appropriate decisions about the most efficient mix of inputs and technologies in production; (3) through an increased ability to adapt to changing technologies, policies, and the external economic environment; and (4) at high enough levels of education, through an ability to generate new, productivity enhancing innovations.

2.38 Farm production studies from a broad range of countries, including several in Latin America, show that higher education levels tend to be associated with significantly higher productivity levels, controlling for other inputs.40 Estimates of the precise impacts of education on farm productivity vary from study to study depending on the country, crop, and level of technology used. Nonetheless, several important lessons come out of these studies about returns to education that are relevant for Guatemala.

First, and perhaps most importantly, the studies tend to find an impact of education on agricultural productivity only after a farmer has attained a minimum number of years of education. Below a certain level, no productivity effect is observed. Specifically,

____

40 See, for example, Lockheed et a1 1980; Jamison and Lau 1992; Moock and Addou 1994; and Hussain and Byerlee 1995. No recent farm-level studies exist for Guatemala, due to data limitations. However, an older study, using data from the 1970s does exist (see Moock and Addou 1994). 50

what appears to be critical is that students achieve a level of fimctional literacy and numeracy that can be sustained over time - so that the cognitive skills they develop as young people influence their production decisions as adults. This highlights the critical importance of increasing primary school retention and completion rates to increasing economic productivity in Guatemala.

0 Second, the returns to education in agriculture tend to be higher in modern than in traditional production environments. In other words, education appears to have its largest impact on productivity in production environments where producers need to make discretionary decisions about the appropriate input mix or about adopting new technologies. This highlights the importance of Guatemala undertaking a set of complementary policies and investments - to strengthen the investment climate, to improve economic governance, and to improve Guatemala's cost competitiveness - in order to maximize the economic returns to human capital.

2.39 While these lessons derive from a literature that focuses on retums to education in agriculture, their relevance extends well beyond the agricultural sector - both in terms of the importance of a minimal level of educational achievement and in terms of the type of economic environment in which returns to education are likely to be greate~t.~'

2.40 Analyses of returns to education in the labor market confirm economic returns to education in the Guatemalan context. Analysis ofthe ENCOVI data, undertaken as part of the World Bank Poverty Assessment for Guatemala (2003), indicates that average returns to an additional year of education were 6 percent in 2000. Returns to education appear to differ according to level and type of education. For example, private returns to completing primary school, measured in terms of increased wage levels, were 15 percent, on average (Table 2.3). Average returns to secondary education are higher; secondary school graduates earn 5 1 percent higher wages than people with no education, on average, and 36 percent higher wages than primary school graduates. University graduates earn about 74 more than people with no education and 24 percent more, on average, than people completing secondary schooling.

41 The role and importance of economic dynamism (whether in the form of new capital investment or technological change) in generating economic retums to education are further highlighted by Rosenzweig (1996), who examines education and productivity (or profitability) among agricultural piece-rate workers, in manufacturing enterprises and, in retums, in Green Revolution agriculture across several countries. 51

Table 2.3: Returns to Education and Training, 2000 Male Female Overall Primary completed (%) ai 11 17 15 Secondary completed (%)‘I 27 54 51 Higher Education completed (%)‘ 74 76 74 Vocationaliother completed bi 0 0 0 Average Yearly Return to Schooling, (%) 3 6 6 Participation in Job Training ‘’ 10 15 da Source: Adapted from Guatemala Poverty Assessment, World Bank (2003), Table 7.3, p: 74, and Vakis (2003), Table 26, p: 59. Returns to Education are the % increase in hourly wages due to educational level increases andor participation in job training. ‘compared with no education b’ coefficient estimates not statistically significant cl compared with no job training

2.41 A few other results ofthe returns to education analysis stand out. First, the findings suggest that there are few private or economic returns to vocational training in Guatemala. Second, in contrast to evidence from many other developing countries, there do appear to be returns associated with participation in job training. Graduates ofjob training programs appear to earn a 10-15 percent premium over those who have not participated in training courses, other factors held constant. And, finally, the evidence indicates that average returns to educating females are higher - at all levels - than average returns to educating males. This latter finding highlights the importance of improving educational access and attainment for girls and women.

2.42 It is important to note that the above rates of return estimates capture private, and not social, returns to education. The estimates measure returns that individual’s receive from education in terms of wage premia and, as such, may not completely reflect productivity differences across different levels of educated workers. Estimated returns to education may not completely reflect productivity, for example, in circumstances where labor and product markets are not competitive - where large firms accrue rents and workers with higher education command some bargaining power in the labor market. The above estimates may also reflect wage premia associated with working in the public sector, where wages do not necessarily capture the marginal product of civil servants efforts to national income.42 For these reasons, separate macroeconomic analysis of the links between education, productivity, and growth is useful.

2.43 These caveats notwithstanding, the lessons from the microeconomic evidence, are clear. First, education has a positive impact on economic productivity and incomes. Second, a minimum level of educational achievement - that enables functional literacy and numeracy - is necessary to ensure those productivity impacts are felt. Third, additional education - above that minimum level - brings not only direct productivity effects, but

42 In general, these issues would tend to lead to over-estimates of returns to higher levels of education and probably have very little impact on estimates of primary, or even possibly secondary education. 52 enables people to increase their productivity through adopting new technologies and to take advantage of new economic opportunities associated with policy reforms and economic change. Finally, economic returns to education tend to be higher in economically and technologically dynamic, rather than in static, environments.

2.44 Education and Economic Growth - Macroeconomic Evidence. A number of cross- country studies find that education plays a critical role in promoting economic growth. A recent study on economic growth in Latin America and the Caribbean finds that education has been one of the key determinants of growth in the region (Loayza, Fajnzylber, and Calderon 2002). Moreover, the authors find that continued advances in education will be (along with infrastructure development) the most powerful engine of growth for countries in the region over the next decade. Specifically, Loayza, Fajnzylber, and Calderon (2002) estimate that if the region’s increasing trends in secondary enrollments continue throughout the decade, that this could be expected to contribute about 0.4 percentage points to the growth rate of GDP per capita. This compares to about 0.25 percentage points as a result of continued trend increased in trade openness, and about half that amount due to continued financial deepening.

2.45 Guatemala-specific evidence tells virtually the same story. A new study that examines 50 years of data from Guatemala - from 195 1 to 2000 - finds that education has been, and will continue to be, a key to economic growth in the country (Loening 2003). In this study, human capital, as measured by the average years of schooling (education stock) among the Guatemalan labor force, has a significant and positive impact on long-run growth in Guatemala. The importance of education capital is not only statistically significant, but sizable. An increase by 1 percentage point of average years of schooling would raise output by about 0.33 percent (Table 4). This analysis, which was undertaken using alternative specifications, is robust to changes in empirical specification and to the use of alternative data series over the period.43

2.46 The study also analyzes separately the impacts of primary, secondary, and tertiary education on growth. The analysis indicates that over the 1951-2002 period, primary schooling had the largest impact on productivity growth at the margin, followed by secondary schooling. Specifically, a one percentage point increase in the proportion ofthe labor force with primary education is found to raise output by 0.35 percent, while a one percentage point increase in the proportion of the labor force with secondary or tertiary education increases output by 0.22 percent and 0.10 percent, respectively (Table 2.4).44

43 The parameter estimates were found to be stable and robust to the use of instrumental variable methods as well as OLS techniques. Estimates were also robust to changes in model specification, including alternative data series for education stock and different assumptions and measures ofphysical capital. For an overview ofthe methods used, see Loening (2004).

44 The growth elasticity estimated for the different levels of education need to be interpreted with some caution. Because of multicollinearity amongst the school level variables, equations had to be estimated separately for primary, secondary, and tertiary education. The elasticity estimates, thus, do not the effect ofone level ofeducation, controlling for the other levels of education. 53

Education Variable Ordinary Least Squares (OLS) Instrumental Variables (IV) Average Years of Schooling 0.35 0.33 Proportion of Labor Force with: Primary Education 0.43 0.35 Secondary Education 0.23 0.22 Tertiary Education 0.10 0.10

2.47 The study also undertakes a “sources of growth” analysis for Guatemala over the 195 1-2002 period, using a traditional Solow growth accounting framework (Loening 2003). This analysis reinforces the importance of human capital to growth in Guatemala. Indeed, the analysis indicates that labor has played a dominant role, explaining about 50 percent of output growth during the past five decades. An extended source of growth analysis is undertaken which makes adjustments for changes in the quality of capital and labor over the 197 1-2002 period (for example, increases in Guatemala’s education stock). When adjustments are for input quality, then quality-adjusted labor now explains about 78 percent of GDP growth over the period. In other words, increases in education were the main driving force behind total factor productivity growth during the period.45

2.48 Differentiating the sources of growth analysis by level of education suggests that the secondary education made the largest contribution to growth over the period, followed closely by primary education (see Tables 2.5 and 2.6). This is the case because the rate of increase in the secondary school-educated workforce was larger, although the marginal impact of primary education on growth was greater than the marginal impact of secondary education over the period.

Table 2.5: Guatemala: Decomposition of GDP Growth, by Level of Education, 1951-2002

GDP Contribution of Time Growth Education R~~~~ Capital Labor TFP Period Primary Secondary Tertiary 195 1-55 2.3 0.6 -1.1 0.0 0.7 -1.1 3.2 1956-60 5.4 1.7 2.0 1.3 1.1 1.1 -1.7 1961-65 5.3 1.1 1.9 1.2 1.2 0.7 -0.8 1966-70 5.8 1.7 1.8 1.4 0.8 0.7 -0.5 1971-75 5.6 1.6 1.1 0.9 0.9 0.7 0.5 1976-80 5.7 2.3 2.7 1.5 1.7 0.8 -3.4 1981-85 -1.1 0.6 -1.0 -0.3 0. I 0.0 -0.6 1986-90 2.9 0.4 1.5 0.8 0.8 0.6 -1.3 1991-95 4.3 0.9 0.6 0. I 0.2 0.5 2.0 1996-00 4.0 1.5 0.4 0.7 0.5 0.2 0.6

45 For further details, see Loening (2004). 54

2001-02 2.3 1.3 0.8 0.6 1.3 0.3 -2.1 1.2 1.o 0.8 0.8 0.4 -0.3 Average 3.9 3 2% 25% 19% 21% 10% -7% Source: Loening (2004).

Table 2.6: Guatemala: Decomposition of GDP Growth, by Level of Education and Adjusted for Quality of Capital, 1971-2002

GDP Contribution of Time Growth Education Period R~~~~ Capital Labor TFP Primary Secondary Tertiary 1971-75 5.6 1.5 1.1 0.9 0.9 0.7 0.6 1976-80 5.7 1.5 2.7 1.5 1.7 0.8 -2.5 1981-85 -1.1 0.2 -1 .o -0.3 0.1 0.0 -0.2 1986-90 2.9 -0.1 1.5 0.8 0.8 0.6 -0.7 1991-95 4.3 1.1 0.6 0.1 0.2 0.5 1.8 1996-00 4.0 1.8 0.4 0.7 0.5 0.2 0.4 2001-02 2.3 1.1 0.8 0.6 1.3 0.3 -1.8 1.o 0.9 0.6 0.7 0.5 -0.2 Average 3.5 28% 25% 18% 21% 14% -6% Source: Loening (2004).

2.49 In sum, the macroeconomic evidence confirms the critical role that education has played in Guatemala’s economic growth over the last 50 years. The analysis indicates that both primary and secondary education is important. Primary education is estimated to have had the largest marginal impact on growth over the period. At the same time, the sources of growth analysis indicate both primary and secondary made substantial contributions to GDP growth over the period. This analysis was undertaken using historical data, beginning at a time when Guatemala’s education stock was considerably less than it is today. For this reason, it is possible that the macro-findings underestimate somewhat the importance of secondary education to meeting future growth challenges. Indeed, the returns to education analysis suggests that the importance of secondary education may have increased in recent years.

2.50 The evidence thus argues for a two-pronged approach to education investments to promote growth. The first-prong would involve completing the incomplete primary school agenda, which will form the basis of a productive society in Guatemala. The second prong would focus on expanding secondary education, as a means to better prepare the country to meet emerging economic opportunities.

Health and Nutrition

2.51 Like education, health is a critical input to human capital, human capacity, and people’s productivity. In Guatemala, chronic malnutrition - or stunting -has a particularly important negative effect on people’s productivity and hinders economic growth. 55

2.52 Health Status and Growth - Microeconomic Evidence. Microeconomic evidence from Guatemala and elsewhere shows that stunting negatively affects people’s economic productivity - through its effect on people’s physical stature, ability to learn, and their ability to carry out physical work and to earn as adults (Martorell 1997). In rural Guatemala, analysis of longitudinal data indicates that stunting reduces children’s intellectual functioning, leading to poorer performance on tests. Several studies using household survey data show a relation between nutritional status and worker productivity, measured in terms of wages or agricultural productivity (Thomas and Strauss 1997; Haddad and Bouis 1991), these findings are echoed in evidence from Guatemala which shows that chronic malnutrition reduced work capacity among men and intellectual performance among both men and women (Martorell 1995).

2.53 Health Status and Growth - Macroeconomic Evidence. One recent cross-country study using historical data found that improved nutrition accounted for an appreciable share of income growth in the past two centuries (Fogel 1994). Another found that life expectancy - a key summary measure of a population’s health status is a significant determinant of economic growth (Barro 200 1). For Guatemala specifically, Loening (2003) examines life expectancy as a determinant of growth from 1961-2001. As in the case of education, the life expectancy variable is highly significant statistically and has a very strong impact on long-run growth. Specifically, the results suggest that a 1 percent increase in life expectancy as associated with about a 1.04 percent in output over the period.46

2.54 These results support the view that to be fully effective human capital policies to promote growth in Guatemala should focus on health - and specifically chronic malnutrition - as well as on education. As in the case of education, the micro- and macro- economic evidence paints a consistent picture of the importance of health as a critical factor that affects the productivity ofhuman capital.

Inequality in Human Capital and Growth

2.55 A growing empirical literature has examined the link between inequality and growth, as pointed out in section IV of Chapter l.47This literature has focused to a large extent on the relationship between income or land inequality and growth, and to a lesser extent on the links between inequality and human capital and growth. Most empirical studies find a negative relationship between initial income or land inequality and growth (e.g., Alesina and Roderik 1994; Persson and Tabellini 1994; Perotii 1996), probably as a result of latent social conflicts and structural obstacles that may impede future economic expansion (e.g., credit market failures that obstruct the poor from exploiting opportunities for human and capital investments) in highly unequal societies. One recent study that

46 Other studies (e.g., Barro 2001) suggest that the life expectancy has such a strong impact on growth because it may proxy, in part, for other non-health related factors, such as social capital or better work habits.

47 For an overview of the empirical evidence see “Inequality in Latin America and the Caribbean: Breaking with History?”, World Bank, 2003. 56 looked explicitly at inequality in human capital and growth, consistent with the findings of these other inequality-growth studies, conclude that initial inequalities in the distribution of human capital have clear negative effects on economic growth (Birdsall and Londoiio 1997).

V. Implications for Policy

2.56 The combined evidence presented here suggests the need for a three-pronged human development strategy to promote economic growth in Guatemala:

1. Completing the unfinished primary education agenda, with special focus on raising primary school quality, retention, and completion rates

2. Strengthening Guatemalan’s productive capacity through an concerted policy to reduce widespread chronic malnutrition, and

3. Laying the groundwork for greater access to and participation in secondary education, to position Guatemala to take full advantage of emerging economic opportunities.

2.57 In order to maximize the benefits from this approach, it will be necessary for Guatemala to address in a fundamental way current inequalities in access to human capital, especially in the context ofcompleting the primary education agenda and attacking chronic malnutrition. It will also be important to undertake complementary policies to improve Guatemala’s investment climate and economic competitiveness, if the country is to maximize the impacts ofits investments in human capital.

Completing the Unfinished Primary Education Agenda - Raising Primary School Quality, Retention and Completion Rates

2.58 Building a strong foundation of quality primary education will be a cornerstone to assuring economic progress in Guatemala. While enrollment rates have risen in recent years, primary school quality remains low and an unacceptably high proportion of primary school students leave school before competing the cycle, sacrificing some of the most important benefits of primary education from a productivity, income, and growth perspective.

2.59 A key element of a human capital development strategy to promote growth in Guatemala must thus include completing this unfinished primary education agenda. Efforts to raising enrollments to universal levels are important, but will be insufficient to achieve the desired productivity and growth impacts. It will be important to move decisively to improve primary school quality, and to increase school retention and completion rates. Key areas for intervention to address these issues include: 57

Continuing to expand access to primary education. The PRONADE program has contributed in important ways to increasing access to education in poor rural and marginalized areas. This model, based on the principles of decentralization, local autonomy, and parental and community participation and supervision, can continue to be effective in expanding access, as part of an integrated program of the Ministry of Education to expand education access and school quality at the primary level.

Improving school quality to raise cognitive achievement, increase education eficiency, retention and completion levels. Several programs, including PRONADE, bilingual, and New Unitary Schools (NEU) all have elements that have been successful in specific communities. What is needed now is to:

o Learn from those successes to develop a flexible, yet integrated approach that includes bilingual learning materials, bilingual education, multi-grade teaching where appropriate, and ongoing student assessment;

o Improve teacher training and education through development of teachers’ guides, in-service training in classroom management, training of teachers in developing a supportive environment for education for girls and indigenous children;

o Improve school quality through institute measures to increase community participation and school-based management. Evidence indicates that where schools had more autonomy in hiring teachers, education quality and student test scores were higher.

Strengthening People’s Productive Capacity Through Better Nutrition

2.60 The links between adequate nutrition, as a critical input into human capital, and people’s productivity are clear. Widespread chronic malnutrition in Guatemala not only affects people’s short-term health, but people’s ability to learn, their physical stature, ability to work, and their economic productivity. Indeed, completing the primary education agenda will be insufficient to ensuring enhanced growth performance, if the significant problem ofchronic malnutrition is not addressed.

2.61 The causes of malnutrition are complex, and can be addressed effectively only by adopting a multi-sectoral approach that addresses nutritional, health, and environmental conditions and promotes behavioral change. The key target groups include women of reproductive age and children under two. A strategy to improve productivity through better nutrition should include efforts to:

Improve prenatal nutrition through counseling on dietary intake and weight gain during pregnancy, and iron and folic acid supplementation provided to pregnant women.

Strengthen mothers ’ infant feeding practices and care behaviors, through information on breastfeeding and complementary feeding, as well as environmental health 58

promotion activities, such as hand washing and training in hygienic water handling practices to reduce post-source contamination.

Reduce environmental risks for common childhood illnesses through improved access to potable water and sanitation, as well as reduction of indoor air pollution from cooking fires.48

Increase access to quality family planning services through increased provision of and access to culturally appropriate information and counseling, as well as a wide choice of family planning methods.49

Strengthen and improve monitoring of food fortification programs countrywide (i.e., fortification of staples with vitamin A, iron, and iodized salt).

Improve access to and use of preventative and curative health services including increased child immunization, growth monitoring, de-worming, and better control of infectious diseases and common childhood illnesses.

2.62 Community-level growth monitoring and nutritiodinfant carehygiene programs, coupled with raising immunization levels and access to health services are among the top priorities for investments to address Guatemala’s severe stunting problem. A central element of this strategy will thus involve the strengthening of the nutritional and basic health services delivered through Ministry of Health centers or Ministry of Health- contracted NGOs (through the Programa de Extension de Cobertura, PEC). Indeed, Guatemala’s innovative contracting of NGOs for community health services through PEC is a model for Latin America, and efforts should be made to further strengthen this program and to extend it to populations not yet reached by existing service providers.

2.63 Moving forcefully to reduce chronic malnutrition, in concert with improving primary school access, quality, and completion, will go far to build a solid foundation for improved productivity and growth in Guatemala.

Expanding Access to and Participation in Secondary Education

2.64 Increasing the pool of secondary-level educated workers will be critical to Guatemala’s hture growth agenda. Indeed, new economic opportunities arising from further international economic integration - through CAFTA and other global developments - will make the presence of higher levels skills increasingly important for the country’s economic growth and competitiveness.

48 Contaminated water cause diarrheal diseases, while indoor air pollution causes respiratory and other health problems in young children, which contribute to and can exacerbate child malnutrition

49 This is important because pregnancies at a young age, high fertility, and short intra-birth intervals are all strongly associated with chronic malnutrition, and because data indicate significant unmet need for family planning services in Guatemala. Indeed, the unmet need for family planning, measured by the proportion of mamed women of reproductive age who would like to space or limit future births but who are not using family planning, was estimated at 28% in 2002. 59

2.65 In expanding access to and participation in secondary education, it will be important to:

Address both demand and supply constraints to secondary school access and participation. Analysis of the ENCOVI (2002) data indicates that while demand side factors - such as the costs of secondary schooling - are the key constraint to greater enrollments in urban areas, supply factors - such as the lack of school facilities - and demand factors are both key constraints to enrollment in rural areas (World Bank 2003). Additional public resources will be required to help break both demand and supply constraints to secondary school expansion.

Foster private and NGO, as well as public sector, participation in the delivery of education services. In contrast to primary education, in which public sector provision predominates, about 55 percent of secondary students are enrolled in private schools and another 10 percent in Cooperative schools in 2000 (World Bank 2003). All three sectors should have an integral role in the expansion of secondary , developing strategic public-private partnerships in education service delivery, where appropriate.

Adopt alternative approaches to expanding secondary schooling opportunities to ensure greatest outreach, particularly in rural areas. This could include, for example, the expansion of the NEU multi-grade model to encompass nine grades, as well as extension of secondary-level distance learning opportunities (telesecundaria), an approach that Guatemala also has some recent experience with.

2.66 To ensure that Guatemala’s investments in human capital are most productive, two other key issues much be addressed. First, it will be critical to address explicitly Guatemala’s persistent inequalities in human capital. In the past, inequalities have been thought of in the context of social equity. Yet recent evidence suggests that inequalities in human capital hinder economic growth. Undertaking active measures to address existing inequalities in education and health will thus be critically important to achieving the unfinished primary education agenda, to effectively addressing chronic malnutrition, and to ensuring that primary school graduates - whether poor or rich - have access to the productivity enhancing impacts of secondary schooling.

2.67 Second, although strengthening the human capital of all Guatemalans is important to fiture economic, human capital investments alone are not a panacea. To make the most productive use of Guatemala’s human capital, it will be necessary to undertake (complementary) policy reforms to increase the country’s economic dynamism and international competitiveness. Indeed, growth regressions for Guatemala suggest that the country still lacks important complementarities between physical capital and human capital that would be necessary to enhance growth and increase total factor productivity (Loening 2003). Moreover, a large body of evidence from around the developing world shows that rekrns to investment in human capital are higher in if they take place in a dynamic rather than static policy and technological environment. The remaining chapters of this report concentrate on outlining key complementary reforms in the investment climate (Chapter 111), national innovation (Chapter IV) and trade (Chapter V). 60

The Issue of Skills Training

2.68 Evidence presented above suggests that participants in job training programs in Guatemala receive earnings premiums of about 10 percent, controlling for other factors. Does this imply that public support for skills training - either through financing or provision - should be part of Guatemala's strategy for human capital development to promote growth? The fact that firms are already investing in job training for their employees and that nearly half of all training is being provided by the private sector suggests that job training in Guatemala is largely a private good, where those investing see private returns to their investments, whether as firms or individuals. While Guatemala's strategy in this area should be private sector led, there may be a role for the public sector in facilitating training or providing financial incentives to firms to train employees (or prospective employees). The role of the government's training institute (INTECAP) in such a strategy is discussed at more length in Chapter IV.

Financing Human Capital Development for Growth

2.69 Strengthening Guatemala's human capital for growth will require a commitment of substantial additional financial resources. Although government spending on education has increased in since the Peace Accords, as of 1999/2000, Guatemala spent less on education as a proportion of GNP than any other country in the region (Figure 2.16). Public sector spending on health is also very low by regional standards (Figure 2.17). More disturbing, however, is that The MSPAS budget has been declining in real terms; during the period 1997 to 2003, the MSPAS budget has dropped by 11 percent in real terms. As a share of the total government budget, health spending dropped from 8.8 to 6.4% from 1997-2003. These trends are in contradiction with what is needed to ensure a health and productive population, and is contrary to the commitments made in the Peace Accords.

i Figure 2.16. Education Spending as a Proportion of GNP, 1999/2000

~ 70

60

50 a3

CI 40 C 30 Q) 20

10

00 61

Source: WB, WDI database, 2003

Figure 2.17. Public Health Spending as a Proportion of GNP 2000

70

60

50 m 40 c)0 8 30 k 20 10

00

Source: WB, WDI database, 2003

2.70 The challenges associated with achieving universal primary completion, reducing malnutrition and expanding opportunities for secondary education cannot be done without significantly increasingfinancing of human capital interventions.

2.7 1 In the case of education, a new World Bank study analyzes the likely fiscal costs of achieving basic education (six years of primary plus 3 years of basic secondary) for all in Latin America and the Caribbean by 2015 (di Gropello, Dubey, and Winkler 2003). The study finds that financing universal basic education in Guatemala will require significant financial resources Specifically, under current growth and public expenditure parameters, and assuming no change in the quality of education, Guatemala faces an annual financing gap of US $32 million (in real 2000 dollars) to achieve universal basic enrollments by 2015. This translates into about an 8.3 percent increase in annual education sector spending.

2.72 Improving the quality as well as the quantity of education will be critical to ensuring the largest growth impacts of education. In this context, the study analyzes the expected financing needs if universal basic enrollments were to be accompanied by the types of quality improvements necessary to maximize the growth impact of additional public investments in education. Under this second scenario, the financing gap is predicted to swell to between US $168 and $186 million per year. Between 2000 and 2003, the Government of Guatemala spent an average of US $384 million per year on the education 62 sector (US $374 million in 2003). This translates into about a 44-48 percent increase in real annual education spending levels.

2.73 The analysis thus suggests a significant range of possible spending increases, depending upon the Government’s fiscal capacity. To the extent that achieving a 44-48 percent increase in education sector spending may be overly ambitious in the short-run, the government might consider a phasing in of spending increases over time, beginning with a goal of achieving the roughly 8.3 percent per year necessary to achieve universal primary education. Additional incremental increases could then be made over time - toward the 44-48 percent benchmark - to ensure that both education access/coverage and education quality issues are adequately and appropriately addressed.

2.74 With respect to confronting chronic malnutrition, financing needs are also significant. The order of magnitude of costs can be illustrated in the context of the PEC program. The Government of Guatemala is currently spending about US $5 per capita on the PEC. Cross-country analysis of the cost of basic health packages suggests, however, that fully funding the package - so that NGOs can properly deliver the complete package of services and the Ministry of Health can properly su ervise its implementation - would require approximately US $12- 18 per person covered. Since the PEC program currently reaches about 3.5 million Guatemalans, if the Government’’ were to fully fund packages to existing beneficiaries, this would imply additional costs of US $24.5-45.5 million, depending on whether a $12/person or $18/person package were chosen.” In addition, if the Ministry of Health were to extend the program to an additional 1.2 million people, as it would like to do, this would add another US $14.4 - 2 1.6 million.

2.75 The total costs associated with increasing outreach of this improved package of basic health and nutrition services would thus range from $38.9-67.1 million, depending on the cost of the per-person package. Such increases would represent a roughly 20-34 percent increase in the current Ministry of Health budget (again depending on the cost of the per person package), and these increases would be expected to have a considerable positive impact on child nutrition over time, with concomitant improvements in children’s economic productivity as adults. Since Ministry of Health spending comprised 37.6 percent of total public health spending in Guatemala in 2002, the proposed spending increases would represent an approximately 7.4- 12.8 percent increase in total public spending on health per annum in Guatemala.52 As with education, these spending increases could be phased in over a several year period, if necessary, in light of fiscal constraints.

50 Ricardo Bitran (2003). This is equal to an increase of US $7*3.5 million people in the case for a $12/person package and an increase of $13*3.5 million people in the case of an $1 8iperson package. ’*It should be noted that amount represents only a part of what would be required for a more comprehensive set of health sector reforms in Guatemala that included, for example, improved hospital care as well as primary health care services. A comparison of Guatemala with other countries in the region, controlling for per capita GDP, suggests that Guatemala would spend 3.1 percent of GDP on health instead of its current 2.25 percent, if its public spending were to be meet regional norms. This implies an increase in the countries health spending of about 50 percent. 63

VI. Conclusion

2.76 This chapter has focused on the state of human capital development in Guatemala, the role of human capital in promoting economic growth in the country, and the key avenues that the country can use to promote greater growth through human capital investments in the medium term. The collection of evidence makes clear that while Guatemala has made recent advances in increasing the education levels and health status of its population in recent years, the country still faces tremendous challenges in developing the human capital ofits population.

0 Education and health indicators remain among the lowest in the region.

0 High inequalities in human capital persist between the rich and poor and between ladino and indigenous communities, and

0 Despite recent increases in government social sector spending, public spending on education and health remain extremely low.

2.77 The collection of evidence also makes clear that strengthening the human capital of its people - both education and health status - will be critical to increasing Guatemala’s economic productivity and growth in the coming years - and to taking advantage of emerging economic opportunities in the regional and global economy. It is estimated that an increase by 1 percentage point of average years of schooling of the Guatemalan labor force would raise output by about 0.33 percent. Strengthening both primary and secondary achievement will be crucial in the medium term, given that state of Guatemala’s human capital. It is also estimated that improving the basic health status of Guatemalans - particularly their nutritional status - will also yield significant growth improvements in the years to come. Global evidence suggests there are also potentially significant growth gains associated with narrowing inequalities in human capital among Guatemalans.

2.78 To meet its economic potential, significant additional efforts will be required to raise basic education levels and improve people’s health status - particularly nutritional levels - of all Guatemalans. This calls for a three-pronged strategy for human capital investment to increase growth:

0 Completing the unfinished primary education agenda, with emphasis on raising primary school quality, retention, and completion rates

0 Strengthening Guatemalan’s productive capacity through improving the nutritional status of the population, and

0 Achieving greater access to and participation in secondary education, to position Guatemala to take full advantage of emerging economic opportunities.

2.79 Tackling the growth agenda through these investments will take considerable additional resources and efforts to strengthen service delivery in the education and health sectors. But the long-term pay-offs ofthese additional investments will also be large. 64 Chapter 111. The Investment Climate in Guatemala

I.Introduction 3.1 Guatemala’s record of economic growth and slow progress in poverty alleviation in recent decades have been closely associated to a low level of investment and a low rate of total factor productivity growth (TFPG), as documented in Chapter I. While these two factors are not perfectly separable, as gross fixed capital formation may also be a vehicle for productivity growth, this chapter focuses on key issues that are at the basis of the disappointing levels of investment. The next chapter focuses on low TFPG by focusing on innovation and technology.

3.2 While Guatemala made significant progress in first generation reforms during the 1990s by lowering inflation, increasing trade integration, liberalizing its financial market and - more recently -- reforming its infrastructure sectors, the resulting growth rates have been disappointing. This is in great part due to the persistence of comparatively low rates of investment. Indeed, the average investment ratio during the 1990s in Guatemala -- roughly 15.6 percent of GDP, a 2.4 percentage points increase from 1980s average - compares poorly with countries such as China, with similar level of development but investment ratios superior to 30 percent - and even to the LAC average of 22 percent of GDP.

3.3 This chapter focuses on the investment climate - i.e., the “costs” of doing business in Guatemala -- which affects the marginal product of physical capital, and accounts for diminished incentives for investment. The chapter centers on three main elements of this climate: (a) the state of governance, with a special emphasis on crime and violence; (b) the provision of infrastructure services; and (c) the development of the financial sector. It argues that removing existing bottlenecks in these areas - essentially second generation reform issues - is essential to boost investment and ensure that Guatemala can fully benefit from the reform agenda already implemented. An initial section provides a general overview of investment climate issues in Guatemala and the final section presents some policy recommendations.

11. The Investment Climate in Guatemala: an overview

3.4 A strong investment climate is needed to provide firms with incentives to invest and prosper in Guatemala. A good investment climate consists of an environment in which firms can realize their productive potential by creating jobs, and providing the goods and services demanded by consumers. This requires a sound macroeconomic environment, the availability of high quality physical and financial infrastructure, skills and technology, the existence of a legal and regulatory framework that promotes competition, and a governance environment that overcomes bureaucratic inefficiencies and promotes growth. The Guatemala Investment Climate Survey (ICs) extensively probed firms’ perceptions of the investment climate in which they operate. This section focuses on key aspects ofthe investment climate as identified by firms in Guatemala. 66

Figure 3.1: .~ - --_____~ _____ I Number of Enterprise Inspections per Year I

3.5 Among the other countries in which the ICs has been implemented - Honduras, Nicaragua, China, India, Pakistan, Cambodia, and Bangladesh - Guatemala compares favorably in several criteria. For example, the average number of enterprise inspections per year in Guatemala is the lowest among the group. As Illustrated in the table below, the number of days required to clear customs is 5 days in Guatemala, 8 days in China and twice that in Pakistan. The average number of days to register a business in Guatemala is lower than neighboring countries and the value added per worker in the garment sector is higher than that in China. Figure 3.2: Number of Days to Register a Business

I 0 20 40 60 80 100 120 141 Source: Doing Business Database 67

Figure 3.3:

Longest Time in Last Year to Clear Customs I 1 25.00 I I I 20.00 I 15.00 I 8 10.00 5.00 I

0.00 I

Figure 3.4:

3.6 Clearly challenges exist in Guatemala's investment climate. Looking closely at respondents' replies, a consistent pattern of concern emerges. Firms are concerned about (a) corruption, (b) crime (c) regulatory and policy uncertainty and (d) macroeconomic instability as key obstacles to a positive investment climate. Within the group of comparator countries, Guatemala leads the pack in the bribe tax (corruption), the time tax, (indicating the regulatory burden on enterprises), and the lowest confidence in the judiciary's ability to uphold property rights. It is important to note that, with the exception of labor regulations, transport and communications, over a third of the firms 68 rank all other constraints as major or severe. This indicates their strong dissatisfaction with the overall investment climate in Guatemala. Poor government effectiveness and weak regulatory quality have weakened the investment climate.

Figure 3.5:

I Percent Firms ranking obstacle as major or severe

Figure 3.6:

~~ Percent d Sales Wue Wd InformallytokMic CHicials 69

Figure 3.7:

Percent of Management Time Spent Dealing with Public Wicials, Regulation

27 ,nPakistan I 22 11

0 0 Pdand m 17 =Bangladesh (I !! 0 CL Guatemala & 12 m 0 a , Hcnduras aNicaragua I/

I Fccd Processing

3.7 Regulatory impediments in Guatemala are especially harmful because they tend to be felt most by the best performing firms in the formal sector and less by firms in the informal sector. Analytical results demonstrate the negative impact of regulatory constraints on firm productivity and growth in Guatemala. Formal firms, and the best performing firms in the manufacturing sector - large scale, exporters, or those with FDI (foreign direct investment) - voice strong concerns about regulation as an obstacle to their operations. Large firms, who have better performance in terms of value added per worker (VAL) and TFP (total factor productivity), identify regulation as a very important obstacle to their operations relative to smaller firms. In contrast, firms in the informal sector appear to be less constrained along all dimensions.

3.8 In the next few sections, we take a closer look at some of these constraints to business growth and their impact on the performance of enterprises. 70

Figure 3.8:

Leading Constraints by Formality I

Tdecmnications

ktmregulations flectricty

Labregulations Bflciercy d legal syste-r Traffipottatm

ucatim of availaMe Wks Tax rats Tax Admnisbabcr

Access to Land

and Feg Mlcy Ulceltainly

kroeconomc hsiabilty Access to financing

Anbconpebwe pracbcs

Carupticn

Cost uf financing Oim 8 Vidence I 00 100 XI0 300 400 500 €00 700 800 900 1030

111. The State of Governance

3.9 Governance issues have become a major source of concern and public debate in Guatemala over the last few years. This seems to reflect both a generalized impression that governance conditions in Guatemala have recently deteriorated as well as a growing consensus about the impact of governance variables such as quality of regulation and rule of law on economic growth.53 Two sources of information are the World Bank’s 2003 Guatemala’s Investment Climate Assessment (ICA) and the governance indicators study prepared by Kaufmann et a1 (2003).

3.10 ICA indicators suggests that the state of governance in Guatemala is among the worst in the LAC region. One major source of information on governance performance

s3 See Kaufmann, D. A. Kraay and M. Mastruzzi, Governance Matters IZZ: Governance indicators for 1996-2002, The World Bank, 2003. Following Kaufmann et a1 (2003) we use a broad definition of governance as “the traditions and institutions by which authority is exercised in a country. This includes the process by which governments are selected, monitored, and replaced; the capacity of the government to effectively formulate and implement sound policies; and the respect of citizens and the state for the institutions that govern economic and social interactions among them.” 71 for Guatemala and comparable countries are the two World Bank surveys54 on the investment climate. Taking into account -the differences in sample sizes and methodologies, a comparison of the results of these two main surveys may be useful. The main results may be summarized as follows: (i)87 percent of the firms indicate that corruption poses a problem for business growth and operation. This is higher than the Central American average (81 percent) and has increased significantly from 24 percent in 2000. (ii)87 percent of the those surveyed reveal that crime and violence are major problems. This response is also well above the Central American average (75 percent) and much higher than the corresponding rate for 2000 (close to 50 percent). (iii) Economic and regulatory policy uncertainty is a major problem for business growth and operation for 76 percent of the respondents. This is higher than the Central American average (68 percent). (iv) Macroeconomic instability is a major obstacle for 71 percent of the firms, higher the Central American average (66 percent). Policy uncertainty also seems to have increased considerably since 2000, when roughly 50 percent of the firms considered economic and financial policies, or in general, rules, laws and regulations fairly unpredictable or worse. (v) Anti-competitive practices are considered a major obstacle for business growth and operation for 70 percent of the firms. This is higher than the Central American average (65 percent) and indicates a significant increase from 2000, when roughly 38 percent of those surveyed declared that anticompetitive behavior by other firms or the government constitute a moderate to serious problem. (vi) Other variables identified as problems for business growth and operation are either at or below the Central American average or are major problems for less than 60 percent ofthe firms.

3.1 1 World Bank Institute indicators confirm poor overall performance in governance area. Kaufmann et al (2003) indicators suggest that Guatemala performs poorly -either when compared to LAC average or Central American countries - in terms of most governance indicators. Their composite governance indicators were drawn from over 190 measures of governance and compiled by organizations worldwide covering 170 countries in 1996-2002 along six dimensions: (i)political stability; (ii)government effectiveness; (iii)regulatory quality; (iv) rule of law and (v) control of corruption. (vi) voice and accountability55. Together, these indicators measure a society’s success in developing an environment in which fair and predictable rules form the basis for economic and social interactions. When compared to LAC averages, all indicators for Guatemala have systematically presented much lower levels during 1996-2002, with the exception of regulatory quality (see Figure 1). Since 1998, regulatory quality, government effectiveness and rule of law indicators have deteriorated. Since the peace accords were signed, very moderate sustained progress has been achieved in political stability and control of corruption indicators. In 2002, Guatemala’s governance performance was among the worst in Central America for all indicators but government effectiveness and regulatory quality (see Figure 2). Persistent perceptions of the deterioration ofthe rule oflaw and a conflictive political environment have contributed to

54 The World Business Environment Survey, 2000 - WBES and the 2004 Guatemala Investment Climate Assessment - ICA 55 Voice and accountabilitjj includes a number of indicators measuring various aspects of the political process, civil liberties, and political rights, as well as indicators measuring the independence of the media. 72 this. After a significant effort in the 1990s focused on modernization of government institutions and market liberalization and regulatory reform, problems at the implementation stage (second-generation type of issues) may have also contributed.

Figure 3.9: Governance Indicators - Latin America & Caribbean and Guatemala (2002)

Latin Flmerica k Caribbean - Regional Average (2002)

Voice and Rccountability Voice ad Accountability

Political Stabllity Pailtical Stabihty

Governnent Effectiveness Gwernnmt Effectiveness

Regulatory Quality Rep.latorj Puality

Rule of tau

Control ot Corruption Cmtrni or Corruption

8 25 58 75 e 25 15

Source: Kaufmann et a1 (2003) 13

Figure 3.10: Governance Indicators - Central America (2002)

Govemant Effectiveoess (Latin Rlerica 6 Caribbean ream, Mo2) Voice and kcountabilitv (Latin Rmerica h Caribbeen reeim. 2302) ...... , ...... I......

E a 75

Rule of La (Latin America h Caribbwn region, 2002) -1--,--7--- -1--,--7---

"A6.6

I I I E- 2J SB n

Political Stability (Latin America h Caribbem Control of Corruption (Latin Pmerica h Caribbea ......

Source: Kaufmann et al(2003). 74

3.12 According to the 2003 Corruption Perception Index (CPI)56, Guatemala ranks 100 out of the 133 countries reported. The CPI captures the degrees of corruption perceived by international and domestic business communities. Compared to other Central America countries, only Honduras ranked below Guatemala in 2003, while in 1998 both Honduras and Nicaragua ranked worse. This result reflects, at least in part, the fact that there have been several highly publicized cases of misuse of public funds, reports of influence peddling, intervention into mismanagement in banks, and failures to prosecute suspects of corrupt activities, despite improvements in public sector financial management and transparency. This has diminished the credibility of some public institutions (CAS, 2002).

3.13 Legal framework and institutions seem to provide reasonable means to fight corruption. The Guatemalan Penal Code provides legal basis for different types of corruption offences. Although there is no explicit characterization of corruption infringement, the Guatemalan Penal Code, specifically in chapter 2, provides several figures that may represent the legal basis for condemning corruption-related offenses. With the enactment of the Constitution in 1985, a new institution, Contraloria General de Cuentas (CGC), was created with the objective of combating corruption. The CGC is a decentralized technical institution, reporting directly to Congress, which controls revenue, expenditures and general fiscal activities. The institution has a good legal framework and a management team with well defined objectives and strategies, it has been restructured and counts among its assets a professional staff and alliances with the social society in order to generate goodwill and confidence in the quality of public expenditures. In a transparent process, the current Contralor has recently been nominated.

3.14 Various plans to improve the management of public funds have been designed since the Peace Accords but they have not yet achieved effective impact. The Bank provided supports through two loans in FY95 and FY98 for one important set of initiatives related to improvement public fund administration by means of an integrated system of financial management (Sistema Integrado de Administracibn Financiera- SIAF). Through SIAF, financial transactions are incorporated into a unique system of public accounting, thereby improving transparency and helping to reduce corruption. There is still need for legal and institutional strengthening within SIAF as well as for the overall anti-corruption system. 57 The CGC has been strengthened, provided with modern control mechanisms, assigned operative auditing functions and started to use results- oriented tools. Two new institutions were created: the Subcontrolar de Calidad de Gasto Publico and the Subcontrolar de Probidad. The mission of the Subcontrolar de Probidad

56 Transparency International, Corruption Perceptions Indexes. 57 Several measures were adopted among which: (i)the creation of a unique database for all financial transactions with open internet access to the public; (ii) the creation of new auditing processes and reduction of practices allowing corruption to take place, (for instance, multiple accounts, discretional payments, ghost suppliers, and prices with penalties for late payment); and (iii)a new and transparent acquisitions system that brings about a significant reduction in the prices paid to providers. In February 2000, a WB report (Guatemala, Expenditure Reform in a Post-Conflict Country, 19617-GU) concluded that with this system, administrative discretion with respect to payments had been reduced. 75 is to control the compulsory wealth statements of public servants. To complete the anti- corruption legal framework, a new law that regulates the integrity and responsibility of public workers has been passed - the Ley de Probidad y Responsabilidad de Funcionarios y Empleados Pziblicos.58 Some training activities and improvements in judicial transparency were implemented with the support of a Bank project.59 Finally, in December 2002, the National Commission for Transparency and Anti-Corruption was formally set up within the National Program for Global Transparency in Guatemala.

3.15 Despite recent measures, there are still at least two potential sources of corruption. On one hand, much ofthe contracting done by the State takes place without the use ofthe tendering procedures established by law. Generally this happens in emergency situations or because of international agreements. On the other hand, making public acquisitions by choosing the best option among those offered, is vulnerable to corruption and might lead to a failure to establish consistent pricing. Usually these acquisitions are prearranged, and the presentation of three bids is a mere formality. Despite the new legal measures, the CGC still suffers significant setbacks. This was recently pointed out by the Contralor and the Bank has undertaken the challenge to overcome it. Major institutional weaknesses are a lack of qualified human resources, the lack of up-to-date technology, the obsolescence of information systems, the deficit in physical and service infrastructure, and the lack ofresources to fulfill the institutional agenda.

3.16 Red tape is seemingly maintained at lower levels. When compared to similar countries, the procedures that need to be fulfilled in order to establish a business in Guatemala do not represent an important burden in terms oftime nor cost,. According to a 2003 World Bank survey,60 registering a business in Guatemala costs $1,185 and requires completing 13 steps, taking an average of39 days. This number is relatively low when compared to the average figure of 74 days for the LAC region. In informal meetings, firms and other business organizations generally agree that this is not a source of major concern. Some efforts to simplify regulatory burden have been made, for example the enactment ofthe Foreign Investment Law that organizes and structures most of the previous rules governing foreign investment into a single legal instrument.

3.17 Competition law enforcement is absent and consumer protection is weak. With respect to laws for competition defense, article 43 of the Constitution recognizes the freedom of industry, commerce and work and prohibits monopolies and privileges (art 130). However, no specific regulation has been approved to further develop these principles and there is not a specific institution in charge of the implementation of competition defense. Currently, a department within the Ministry of Economy is in charge ofthese issues. A law for the promotion of competition has been drafted, but has not yet been sent to Congress. The Law for the Protection of Consumers Rights was issued in 2002, but there is no consensus amongst the business representatives. They argue that the new law presents serious drawbacks. The Association for Consumers

'*The law has received some criticisms, for instance, the fact that the wealth statements of the public servants reviewed by the Subcontrolador de Probidad will be treated as confidential and data will be verifiable only by means of a judicial process. 59 Judicial Reform Project. Loan No. 4401-GT. The World Bank. 6o Doing Business in 2004, The World Bank Group. 76

Defense (INDECOM) also criticizes this norm by considering that in certain articles it is discretional. The law gives the Office for the Attention and Assistance to Consumers (DIAC0)the ability to assess fines but these are based on ill-specified technical parameters. Moreover, the alleged ambiguities and contradictions can make the commercial relations and the relationship between clients and providers difficult. 3.18 As in most LAC countries, the enforcement of property rights has improved in Guatemala, although illegality seems to be dominant. Between 1994 and 2002, piracy rates61 in the Latin American region dropped 23 points, from 78 percent to 55 percent. Guatemala exhibited the largest drop, from 94 percent in 1994 to 6 1 percent in 2002, with a large improvement concentrated in the last year, as Figure 3 shows.62 Honduras dropped from 89 percent in 1994 to 66 percent in 2002. El Salvador decreased its piracy rate 29 points, fiom 97 percent to 68 percent in the same time period. Nicaragua and Costa Rica, the two countries with the highest rates in the Central American region, declined 17 and 27 points, respectively. It has been estimated that the total cost of software piracy in Guatemala is $13.2 million. However, Guatemala performs worse with respect to more general property right indicators, such as the property rights protection in the Index of Economic Freedom of the Heritage Foundation, which, in 2003, rates Guatemala at a value of 4 (1 being maximum and 5 minimum protection score).63 Figure 3.1 1: Central America Countries for Software Piracy: 1994-1999

Software Piracy: 1994-2002 1QQ _-~______II______.I______..._l.._. ll"-.l..l_l.ll.lll_ll_ 1 95 ---

90 ~~ - a5 --- 80 --- 75 -- 70 --- 65 ~~ - 60 --- 55 --~ 150' 1 I 1994 1995 1996 1997 1998 1999 2000 2001 2002 ~~ -t- Costa Rica 0 Salvador --Guatemala I -3w- Honduras -.c- Nicaragua +Panama I-Total Latin America

Source: Business Software Alliance, 2003.

3.19 Better enforcement of property rights in the last five years, has resulted, in part, from better laws and institutions. In 1999, Guatemala ranked 18 on a list of 25 countries

6' Business Software Alliance, Eight Annual Global Software Piracy Study. Trends in Software Piracy, 1994-2002, June 2003. The software piracy rate is defined as the volume of software pirated (difference between the applications installed and those legally shipped) as a percent of total software installed in each country. 62 Recently, Guatemala has implemented a program launched by Business Software Alliance, called La Tregua, to facilitate that firms using some illegal software change to legal programs voluntarily. 63 http://cf.heritage.orgiindex/indexoffreedom.cfm 77 evaluated on software piracy. The Industrial Property Rights Law was approved in 2000 (Decree 57-2000) and regulated by Government Agreement in 2002 (n. 89-2002). This norm includes the protection of brands and patents registered in Guatemala and elsewhere. Patents are granted for 15 years, with the exception of those related to chemical compounds, such as foods, drinks, pharmaceuticals, and agrochemical products, which last only 10 years. Also, the Guatemalan Constitution guarantees protection to copyrights and industrial property rights. The State of Guatemala recently ratified the Bern Convention. Decree 57-2000 also provides for the public prosecution of piracy acts. The Property Register has recently been going through a renovation process and it is about to launch an internet service. Other reforms have contributed to improve this service.

3.20 The Land registry remains a bottleneck and, as such, land tenure remains uncertain. In 1998, the Bank approved a loan to support a Land Administration Project with a dual goal: to increase legal security of land tenure and to strengthen the legal and institutional framework. Despite considerable advances in cadastral surveying of land parcels (mostly urban, with less success in rural areas), two important challenges remain: (i)the consolidation of the procedures and institutional framework for the cadastre and (ii)merger of the cadastral process with the legal registry (Registro General de la Propiedud, RGP) following a parcel-based volio real), as opposed to the current deed- based, registration method. At present, Congress is considering a draft law (called Ley del Registro de Informacibn Catastral, FUC) which largely addresses the first challenge, but does not involve the actual merger of the cadastre and the registration functions. For this merger to succeed, significant reforms at the RGP are needed. Currently, the RGP operates as an autonomous public entity. The Director is appointed by the President, and the RGP is funded by the registration fees and services, without direct financial oversight from the Controller’s office (since they do not receive transfers from the Treasury) or Congress. The crisis at the RGP in mid-2003, involving the loss of registration data, shut down of services, and corruption allegations exposed the vulnerability of the institution and the need for major reforms.

3.21 The capacity ofthe judicial system to enforce contracts and resolve legal conflicts has traditionally been low, but there has been some recent progress in terms of case handling. The judiciary performance in Guatemala has been constrained by scarce material and human resources, as well as by procedures and inefficiencies that have proven difficult to eradicate. In 2002, there were a total of 637 tribunals and of 752 judges in G~atemala.~~Compared to 1997, these figures reflect an significant increase in material and human resources (at 73 percent and 5 1 percent respectively). The number of cases under consideration in the period running from January to October 2002 was 276,456, ofwhich 45,032 were finalized (roughly 16 percent). Approximately 76 percent of these were criminal cases. The indicators on the relative supply of different human resources (prosecutors, judges and defense attorneys) in the judicial system, show that Guatemala does not compare badly with other Latin American countries. Preliminary

64 Data from the Instancia Coordinadora de la Modernizacion del Sector Justicia, cited by Pasara, Reforma y desaJos de la justicia en Guatemala, CEJA-INECIP, Buenos Aires 2003. 78 information also suggests that performance seems to be satisfactory, with the rate for undertaken trials versus scheduled ones being close to that ofChile (see Table 3.1).

3.22 The situation is fairly different if one looks at contract enforceability with dispute settlement imposing a tremendous cost in doing business in Guatemala. According to a 2003 World Bank survey,65the average wait for firms before a conflict gets settled is about four years. This contrasts with average for the LAC region of about one year. The long delays in reaching a solution are due to congested courts and to the abusive use of appeal procedures taken to the Constitutional Court, thus allowing disputes to be extended indefinitely. Although the comparison should be made with caution, preliminary data from the ICA indicates that the importance ofthe impact ofthe judiciary performance on business has increased in the last three years. According to the WBES (2000) less than 19 percent ofthe firms considered the judiciary function a major obstacle for business operation and another 27 percent considered it a moderate problem. However, the ICA (2003) indicates that roughly 62 percent of the firms considered the efficiency of the legal system and the conflict resolution mechanisms a major to very severe problem. (see Figure 5).

Table 3.1: Human resources and performance of the Judiciary System in selected countries

Prosec- Judges Defense Trials Undertaken Crime Days utors attorneys per trials1 Reports btwn judge scheduled I crime (per 100 thousand inhabitants) trials( 1000 and percent) inhab trial Cordoba (Arg) 8.5 2.8 1.40 0.9 83 27.5 500 Costa Rica 6.5 2.9 5.73 1.9 30 31.5 900 Chile 4.1 2.2 2.60 1.o 80 91.6 196 Ecuador 2.7 1.o 0.26 1.6 27 10.1 268 El Salvador 9.9 1.o 4.26 3.6 41 14.3 -- Guatemala 4.5 1.o 3.92 1.o 76 18.6 732 Paraguay 3.2 0.9 1.70 0.8 76 5.9 368 Venezuela 0.5 17 566

Source: Centro de Estudios de Justicia de las Americas (CEJA), Seguimiento de 10s Procesos de Reforma Judicial en AmPrica Latina, August 2003. 3.23 After the peace accords were signed, judicial institution modernization reforms were initiated.66 Towards this end, the Commission for the Strengthening of Justice and the Instance for the Coordination of the Judicial System M~dernization~~were created, the Plan for the Modernization of the Judicial Institution and several programs for the strengthening of the Public Ministry (in charge of public prosecution) as well as the

65 Doing Business in 2004, The World Bank Group. 66 The ongoing Judicial Reform Project (WB Loan No. 4401-GT) is supporting efforts to improve the fimctions and services of the judicial system, expand the access to justice, strengthen the administrative management, improve the professional capacity ofjudges, and combat corruption. 6’ Respectively, the Comisibn de Fortalecimiento de la Justicia and the Instancia Coordinadora de la Modernizacih del Sector Justicia. 79

Institute for the Public Defense were launched. Furthermore, several decentralization measures have been undertaken. For instance, the pilot project for the creation of the Judicial Complex of the Department of Huehuetenango, is an example of administrative regionalization that will help to alleviate operational concentration. Also, reforms to the Penal code passed in 2003, are aimed at speeding up the functioning of courts of first instance, by allowing the peace courts to rule over the offenses of lesser importance.

3.24 An unequal workload allocation in the courts and an inefficient assignment of administrative support, impedes judges ability to optimize time allocation and forces them to inappropriately delegate functions to less qualified personnel. All ofthis imposes a high cost in terms of the quality of resolutions, and generates significant delays in the administration of justice. The problem is further aggravated in certain judiciary institutions by the lack of internal rulings, of personnel evaluation, and by a system based on sanctions for administrative misbehavior. Also, taking into account that the number of conflicts brought to court has increased substantially over the past years (15 percent increase in 1999, 11 percent in 2000 and 8 percent in 2001), the judiciary system’s stability and its sustainability in the long run could be threatened, if further budget cuts are implemented. After experiencing a significant increase in the period from 1998-200 1, the budget of the judicial authority has suffered a reduction in absolute terms over the last two years. In 2002, the government assigned 3.44 percent of the public budget to the judiciary system (which represented a 0.47 percent of GDP); in 2003, this percentage decreased to 2.93 percent (0.44 percent of GDP) (see Table 2). The abusive use of appeals on the grounds of unconstitutionality is another impediment to better judiciary performance. In Guatemala, the right of appeal is granted by the Constitution (art 265) as a safeguard mechanism for fundamental rights. However, the abusive use of such appeals is imposing a substantial burden in the judicial system and as a result, there are significant delays in conflict resolution. The available statistical information reveals that appeals are used mostly as an extraordinary resource against jurisdictional actions that frequently do not satisfy the legal requirement of being subject to appeal within the corresponding process. Of all appeals presented to the Constitutional Court, more than 70 percent have to do with issues judged by ordinary courts and of this 70 percent, 4 out 5 get denied by the higher court. There is a penalty for improper use ofthe appeal, but its insignificant amount, 1,000 Quetzals, does not act as an effective disincentive. The Commission for the Strengthening of Justice has warned about the negative effects ofthe misuse of these appeals and has pointed out that this generalized practice is one of the main reasons for the delays in justice administration in Guatemala. 80

Table 3. 2: Budget Judicial System (*) in Guatemala Budget Budget Disbursed / General GDP Approved Disbursed Approved Budget (million US$) (million US$) ( percent) (million US$) (million US$) 1998 57.6 38.2 66.4 1999 85.7 52.8 61.6 2000 107.6 69.3 64.5 2001 115.5 86.16 74.6 2002 102.8 63.7 (**) 61.7 3,007 22,07 1 2003 114.2 3,901 25,749 (*) Includes all courts (Supreme Court, Appeals Court, First Instance Courts, Second Instance Courts, and Peace Courts); (**)July 30th Source: Movimiento Pro Justicia, Fundacion Myma Mack, Andlisis Econdmico del Presupuesto; Sector Justicia de 10s a6os 1998 - 2002 yproyecto depresupuesto 2003, October 2002, cited by the Instituto de Estudios Comparados en Ciencias Penales y Sociales (INECIP), in its Segundo Informe de Monitoreo Anual sobre Independencia Judicial y Asociacionismo en Guatemala, 2003.

3.25 Given the slow pace at which the judiciary system delivers resolutions, alternative mechanisms for conflict resolution are being put into place. These mechanisms are regulated by the Arbitrage Law, decree 67-95, which is based on a model proposed by the UN Commission for International Commercial Law (CNUDMI). Guatemala is a member of the New York Convention, which recognizes and enforces foreign arbitrage rulings and the Arbitrage Law. In 2001 there were 5 Mediation Centers outside the capital. They received 3,907 demands, ofwhich 1,978 were mediated and 1,308 reached an agreement. It is becoming fairly frequent to use the services ofthe mediation and arbitrage instances, and many commercial contracts include clauses to this respect as an alternative way for conflict resolution. It is a relatively expensive procedure with tariffs generally fixed at around 10 percent of the amount under litigation. This high cost limits the use of this mechanism by SMEs (small and medium enterprises). Because of this, large firms are the ones who utilize these services. The Commission for the Strengthening of Justice has recommended the generalization ofthese extra-judiciary dispute settlement practices, but has warned that conciliation, mediation and arbitrage should not become a private service available only to those who can afford it. Rather, the State must offer this service as an alternative to regular court procedures and should favor open access to all firms and citizens.

IV. Crime and Violence

3.26 Guatemala has long been one of the most violent societies in Central America. The country is still suffering the effects of an armed internal conflict that lasted more than four decades. Seventeen years after the return of civilian rule and seven years after the signing ofthe peace accords, generalized violence remains a major concern.

3.27 Available evidence suggests that crime and violence are a top-priority issue for the Guatemala population regardless income levels or economic activity. A 2001 study conducted in urban low-income communities, concluded that violence ranked much higher than several other problems affecting these communities, such as lack of public 81 services, unemployment, and other factors affecting cost of living.68 A 1998 study consistently ranked Guatemala as the country with the most armed assaults in Latin America and the Caribbean, with even higher rates than Brazil and Colombia69. A study based on the results of the 1999 national survey of household victimization, reveals that within a period of 12 months, 40 percent of the population has been a victim of robbery, armed assault, threat of physical aggression and sexual assault. Only 1 out of 5 of the aforementioned cases was reported to the authorities. Similar results still prevail in 2003.70 The 2000 WBES survey reported that more than 90 percent of all firms considered crime and violence a moderate to major obstacle to business development, ranking the topic much higher than other factors affecting the costs of doing business in the country. Three years later, the preliminary results of the 2003 Guatemala ICA indicate that this situation remains unchanged. In April-2003 survey, 4 out of 10 entities had been the victim of at least one criminal act since April 2002, with higher incidence in the large firms (66 percent declared themselves as victims). Ofall cases, 20 percent were not reported, due to lack of confidence in the local authorities in charge of public security. Of all the firms surveyed, 66 percent thought that the authorities were very inefficient, and only 1 percent ofthem was satisfied with their perf~rmance.~’

3.28 Both organized crime and street crime are considered to be major obstacles for business operation. According to WBES, in 2000, almost 50 percent of the firms considered street crime a major obstacle to the business environment. This figure, similar to that of Honduras, is the second highest in Central America, after El Salvador. It is above the Latin American and Caribbean average (43 percent) and much higher than the world average in countries with similar income level (34 percent). With regard to organized crime, the results of WBES are similar: 47 percent of the firms consider this a major problem to business development. Again this figure is worse than the LAC average (35 percent) and the average for countries with similar incomes (30 percent).

3.29 Data also indicates that crime and violent activities have increased over the last three years reversing the first achievement of the peace accords. Despite disparity in data on crime and violent activities, different sources agree that the situation has deteriorated in the past two or three years. For instance, the average number of monthly human rights violations verified by the Misi6n de Verificacih de las Naciones Unidas en Guatemala (MINLJGUA) has increased from 231 in 1998 to 489 in 200272. The figures provided by the PNC with respect to the number of violent deaths also show a increasing tendency, especially during 2002. This means that the initial improvements reached after the 1996

68Moser, C. and C. McilWaine, Violence in a Post-Conflict Context: Urban Poor Perceptions from Guatemala, The World Bank, 2001. On average for the 9 urban communities under study, 48 percent of problems cited were related to different types of violence. In this category, the most pervasive ones were theft, gangs and intrafamily violence. In contrast, concerns related to the lack of physical capital and of social capital represented, respectively 26 percent and 10 percent of problems cited. 69Accordingto Alvazzi del Fratte, Victims of Crime in the Developing World, paper 57, UNICRI, 1998, Guatemala is the country with more armed assaults in Latin America and Caribe, with rates higher than Brazzil and . ’O CIEN, Estudio sobre la magnitudy el cost0 de la violencia en Guatemala, May 2002. 71 Asociacion de Investigacion y Estudios Sociales, XVII Encuesta Empresarial, Guatemala, June 2003. l2PNUD, Guatemala: Una Agenda para el Desarrollo Humano, Sexto Informe Nacional sobre Desarrollo Humano, 2003. 82 peace accords, have been reversed and that in 2002, violence was back to its 1996 levels. Informal evidence seems to confirm that during 2003 this increase in violence has been maintained and even accelerated.

Figure 3.12: Violent deaths, 1995-2002 Figure 3.13: Monthly violent deaths, 2000-2002

$ + ea ,t.

d xb

f& :x.

iw

c tY

b" I/ X?U).Lli

Source: Pollcia Nacional Civil, Guatemala

3.30 The occurrences of homicide are not distributed evenly across the of Guatemala. Important regional disparities are present, with ten departments showing higher homicide rates than the national average. 73 The crime rates are very high in the northern department of Peth and those at the border with Honduras and El Salvador. Particularly for the period from 1986- 1998, Pet6n and Jutiapa had average homicide rates of 57.6 and 53.3 per 100,000 inhabitants respectively, which are high according to international standard^.'^ By contrast, the very populated department of Guatemala, where the capital is located, had an average rate of 27.3 lower than the LAC average. These results seem to indicate that violence is not an urban phenomenon in Guatemala, which contradicts evidence gathered for Brazil, Colombia, Peru and El Salvador. This might be related to the fact that Guatemala has one of the lowest levels of urban concentration in the region. As in most countries, criminal behavior in Guatemala has been related to organized crime, mostly connected to international drug dealing structures and mafias, and to gangs involved in common violence or street crime.

3.3 1 Organized crime is strongly related to drug-dealing activities and corruption. Guatemala is considered to be a major transshipment point for U.S.-bound drugs, particularly Colombian cocaine. Guatemalan authorities used to seize approximately 10 tons ofcocaine a year, but since 2000 the interdiction rate dropped to an average of 2 tons a year. Guatemala's anti-narcotics police unit (known as DOAN) was plagued by corruption scandals. Some of its members were accused to keep part of the officially seized drugs, and were linked to drug-related murders of both drug-traffickers and

73 Centro de Investigaciones Economicas Nacionales (CIEN), Estudio sobre la magnitud y el coste de la violencia en Guatemala, May 2002. 74 It is difficult to find data that allow intemational comparisons. Londoiio, J.L. and R. Guerrero, in Violencia en AmCrica Latina. Epidemiologia y Costos, IDB, documento de trabajo R-375, 1999, calculate that for 1996 the rate of homicides per 100,000 inhabitants in Latin America and Caribe was close to 30 and that this rate was approximately five times higher than the world average. 83

civilians75. The agency was finally abolished in October, and a new structure was established. There is also evidence of the involvement of former members ofthe military in drug trafficking. Moreover, some of the people implicated in these activities are suspected to have close ties to high-level government officials. Not surprisingly, the Guatemalan government’s attempts to fight corruption have been fairly ineffe~tive.~~

3.32 Maras (youth gangs) have existed in Guatemala since the 1980s, mainly in urban areas but have recently become more violent. They generally consist of 30 to 40 youth, with the average age of 14. Every mara has its own history, codes, language, conflicts, and alliances and often fights each other to defend their territory. There are also “ethnic maras,” consisting of individuals from a single indigenous group. These are probably a result of the internal displacement of indigenous people to Guatemala City during the civil war77. The Guatemalan maras, are reported to be much less violent and destructive than their Salvadoran namesakes.78 A 1996 study of the maras in San Antonio de Padua found that most of the Guatemalan maras’ delinquency involves low-level mugging and pi~kpocketing.~~Recent anecdotal reports and press information, however, suggest that this is changing, partly as a result ofguerrilla demobilization.

3.33 Factors often considered as structural determinants of violence are present in Guatemala. Guatemala has one of the most unequal distribution of income in the world, with over half the population living in poverty and nearly a fifth in extreme poverty. The weak financial situation ofthe state, combined with widespread corruption, undermine its ability to design policies to curb unemployment and provide basic services, including effective law enforcement. 8o Furthermore, in societies that have suffered recent episodes of internal conflict, such as El Salvador and Guatemala, it can also be argued that the increase of crime in the last few years in Guatemala could be related to the drastic reduction ofthe army and the weak legal, judicial and security system, the relatively easy

75 In fact, the US administration, especially concerned about the increased drug-traffic and corruption, decided to “decertify” Guatemala last January 2003. This will prevent the country from benefiting from trade arrangements, particularly relevant now that the CAFTA is under negotiation. Despite the decertification, Guatemala has received a temporary waiver so that the country may still receive international loans and technical assistance. Guatemala is supposed to comply with a set of tough targets on drug-interdiction and on extradition of Guatemalans suspected of drug-trafficking offences to the US. 76 Religious Task Force on Central America and Mexico, Central America /Mexico Report, March 2003. 77 Rodgers, D. Youth Gangs and Violence in Latin America and the Caribbean: a Literature Survey, LCR Sustainable Development Working Paper No.4, Urban Peace Program Series, The World Bank, August 1999. 78 Moser, C. and B. van Bronkhorst, Youth Violence in Latin America and the Caribbean: Costs, Causes, and Interventions, LCR Sustainable Development Working Paper No. 3, Urban Peace Program Series The World Bank, August 1999. 79 Rodgers (1999). 8o Fajnzylber, P., D. Lederman and N. Loayza, “Crime and Victimization. An Economic Perspective”, ne Journal of the Latin American and Caribbean Economic Association, 2000. This econometric cross- country study about the economic determinants of homicide and robbery rates concludes that “income inequality and more generally, an unequal distribution of economic opportunities and police protection strongly promote crime.” Moreover they wam about the adverse effects on crime of expenditure cuts in police personnel and equipment and in social programs that tend to benefit the disadvantaged, typically applied in times of recession. 84 access to weapons and the lack of social pressure condemning its possession and use are also relevant factors that impede violence control.

3.34 The total number of firearms in Guatemala, a factor considered to increase the probability of occurrence of crime and violent activities, is estimated to be between 1.5 and 1.8 million. These estimates are based on the official figures about ammunition and this is a very large number considering the population is less than 12 million. By June 2001, the Direccidn de Armas y Municiones (DECAM) had registered only 172,982 firearms. These fireamqhowever, belonged to 57,000 persons, implying a very high average of 3 arms per individual name.81 Consistently, roughly 75 percent of the arms involved in criminal activities and 90 percent of those confiscated by the National Civil Police are not legal. Not only is registry enforcement weak, but regulation is also poor.

3.35 According to Guatemalan regulations there are no limits with respect to the number of arms that can be owned. Also, every person with legal authorization to carry a weapon is allowed to buy unlimited amounts of ammunition. This means that a large quantity of ammunition can be legally obtained to later serve the illegal market. Other statistics also point out that the effective number of weapons in circulation is much higher than the official records. The Mission for the Verification of the Peace Agreements Fulfillment considers that the lack of well defined arms control initiatives by the government has favored the increase in the number ofarms that are carried by individuals and the proliferation of self-defense groups. Actions of private justice and lynching of presumed delinquents has also been attributed to this. As a result, it has become more difficult to implement solutions to the problem ofviolence.

3.36 The material losses associated with the occurrence of violent acts and its prevention, both in families and business, are close to 6.8 percent of GNP (1.85 percent corresponding to costs of public security)82. This figure is higher than those for Colombia (6.4 percent), Venezuela (6.6 percent), El Salvador (4.9 percent), Mexico (3.6 percent), Brazil (1.4 percent), and Peru (1.4 percent). 83 This estimate is conservative since it does not include indirect costs such as medical attention ofthe injured, the loss of human capital, the negative impact to foreign investment and the costs of deterren~e.~~ According to a business survey undertaken in 2003 Guatemalan firms, on average, spend 7 percent of their total costs for private security. In 1999 the Chamber of Commerce estimated that the total costs to the private sector for private security amounted to 1.06 percent of GNP, and represented 5 8 percent ofpublic expenditures dedicated to defense, security and justice for the same year.

3.37 Private security services are employing two times more agents than the Policia Nacional Civil (PNC) which is understaffed. It is estimated that the number of illegal

" Similar estimates about the total number of weapons are mentioned by Fundacidn Arias para la paz y el progreso humano, El arsenal invisible. Armas livianas y seguridad ciudadana en la posguerra centroamericana, 200 1. '*CIEN (2002). 83 Londoiio, J.L. and R. Guerrero, Violencia en Am6rica Latina. Epidemiolog'a y Costos, Documento de Trabajo R-375, IDB, 1999. 84 Asociacidn de Investigacidn y Estudios Sociales (ASIES), XVII Encuesta Empresarial, June 2003. 85 firms operating in private security has tripled since 1996. Roughly 90 private security services were registered in Guatemala in 2001, while 25 to 50 firms were active although not legally and 63 were in the process of getting their license. Private security firms are in 25 percent ofthe cases administered by ex-members ofthe police and the remaining 75 percent by ex-army membersSg5These firms employ about 35,000 armed guards, of which about one third are illegal. For its part, the Policia Nacional Civil employs 18,3 14 agents. According to MINUGUA, the number of PNC officers in Guatemala is equivalent to that of El Salvador, a country that presents similar levels of crime and violence but half ofthe territory size and one fifth the population.86

3.38 Poor regulation of private security also facilitates corruption, crime and violence. In general, private security firms do not have well specified principles guiding their hiring policies, nor training programs prior to the commencement ofduty. They also lack a mechanism to supervise and control the performance of their agents. They offer low salaries, no personal insurance and very poor material conditions to perform the job. The turnover rate is also very high (jobs last an average of 4 to 6 months). All these factors contribute to making their employees highly vulnerable and prone to influence from organized crime bands.

3.39 Most actions undertaken by the Guatemalan government in the past years failed to be effective due to a lack of coordination, resources and appropriate strategy. Main measures were defined in the broader policy context of implementation of the peace accords. Particular emphasis was put on those initiatives to ensure the protection of human rights and to give an active role to civil society through the stren thening the National Civil Police, the Office of the Prosecutor and the Judicial System.’7 Although these institutions have experienced some restructuring in the past years, M!3UGUA88 estimates that they still demonstrate “poor coordination, and suffer from a lack of resources, inadequate training of personnel, and endemic corruption”. Also, emerging international consensus on policy approaches to combating crime and violence emphasizes specific crime and violence prevention interventions, focusing at the local level and targeting risk factors such as easy access to firearms, school drop-outs, family and media violence and unemployment. Experience from within LAC and elsewhere suggests that effective crime and violence prevention requires a comprehensive strategy combining judicial/policing reform, social prevention and situational prevention.

85 This last number is at odds with the police data that instead considers that only 40 percent are controlled by ex-amy staff, Rodriguez, M., Diagndstico sobre la situacidn actual de las armas ligeras y la violencia en Guatemala, Consejo de Investigaciones e Informacion en Desarrollo (CIID). 86 In El Salvador there are 16,000 operational officers and 3,000 more dedicated to administrative tasks, a total similar to that in Guatemala. 87 In particular, the two accords more closely related to public security are the Acuerdo Global sobre Derechos Humanos and the Acuerdo sobre Fortalecimiento del Poder Civil y funcidn del Ejircito en una sociedad democratica. 88 MINUGUA, Hacia una Guatemala segura: un plan integral para el fortalecimiento de la seguridad publica, 2003. 86

V. Infrastructure

Telecommunications 3.40 Since 1999, access to telephone service has substantially increased, specifically in the mobile phone segment. The number of total lines more than doubled between 1999- 2002, with mobile lines increasing more than threefold. Supply of fixed phone service is concentrated in metropolitan areas, especially in Guatemala City, where 69 percent of the investment in new fixed lines took place. Despite this large investment, Guatemala has a low telephone density compared with its neighbors. In 2001 [DATA FOR 2003?], the density of fixed phones in Guatemala was lower than those in El Salvador, Mexico, Panama, and Costa Rica. Nevertheless, the mobile phone density is only lower than that ofMexico and Panama.

3.41 Telecom tariffs are also relatively low. Regarding fixed lines, local telephone tariffs, on average, amount to the equivalent of US$0.025, a high level compared to the tariff in Costa Rica (US$0.008), but lower than that of El Salvador (US$0.039). The commercial tariff is a fixed monthly charge of about US$5.5 which is very low compared to the prevailing commercial fixed charge in other Central American countries in the range of US$13 to US$15. Still, this charge is higher than that of Costa Rica. The competitive fixed line market has reduced the price of intemational calls significantly, from US$ 0.60 in 2000 to US$ 0.36 in 2003. This has produced a strong increase in the level of international telephone traffic, which has reached 52.1 million minutes of outgoing calls in the second quarter of 2003, versus 39.6 million minutes of outgoing calls in the same period for 2002. As for mobile telephone tariffs, a very competitive market has also resulted in tariff reductions. One prepaid call costs 1.0 Q/minute (US$0.12), which is low compared to other Latin American countries, because of the very low fixed-to-mobile interconnection charge (US$O.O 15/minute).

Figure 3.14: Telecommunications in Guatemala ource: Superintendencia de Telecomunicaciones

Telephone Lines in Guatemala Mobile and Mainlines Phone, 2001

500.000

0

__- v Fxrd = Mobbrl 0 Total IT---e 1995Mainlineo 2001Ma1nlines 0 1995Moblle 0 2001mobiie

3.42 Guatemala has one of the lowest rates of internet access in Central and Latin America. Very different figures are provided about internet users. The most recent 87 estimation is that only 1.4 percent of the population has access to internet, a figure comparable to El Salvador but very low as compared to Mexico (4.7 percent) and Costa Rica (9.3 percent). One ofthe reasons for the low internet access is the high cost of local calls. One hour of internet use costs Q 21.0. A flat rate for internet access would contribute to solve the cost problem, but Guatemalan law does not permit Superintendencia de Telecomunicaciones (SIT) to regulate internet tariffs.

Table 3.3: Guatemalan average rates for calls in the fixed lines services (2003) Monthly charge Cost of 1 minute call Residential Commercial National Central America USA Guatemala 5.5 0.025 0.2 0.362 Costa Rica 0.004 0.005 0.008 0.4 0.45 Nicaragua 4.9 13.08 0.021 0.4 0.90 (1) Honduras 2.28 5.7 0.02 0.4 1.04(2) El Salvador (3) 8.34 14.17 0.039 0.34 0.16 Source: SIECA. October, 2003

Users, Increase Population Current Users, Users Population, 2003 2oooyear most recent data ( YO) $?::!Penetration l_._.______lll--^_ --^---___- ~ -___-_I_- _I_ Belize 257,400 15,000 22,000 1.7 46.7 8.5 Costa Rica 4,148,500 250,000 384,000 29.2 53.6 9.3 El Salvador 6,178,700 40,000 300,000 22.8 650.0 4.9 Guatemala 14,223,400 65,000 200,000 15.2 207.7 1.4 Honduras 6,606,100 40,000 200,000 15.2 400.0 3.0 Nicaragua 5,777,700 50,000 90,000 6.8 80.0 1.6 Panama 2,991,000 45,000 120,000 9.1 166.7 4.0 Total Central America 40,182,800 505,000 1,3 16,000 100.0 160.6 3.3 Source: ExitoExnortador.com

3.43 After the reforms ofthe sector, Guatemala has one ofthe most deregulated environments in Latin America. In 1996, by Decree 94-96, a new legal framework was issued in order to introduce competition in the telecommunications market. No license or governmental permit is required for new operators to enter the industry. Providers and consumers agree on the price of every service. Furthermore, firms do not have the duty to inform the regulator about the contractual conditions, since the contents of every contract are private. Telecommunication operators are not required to make any investment in local network, or mobile infrastructure. Access to essential facilities is the only regulated issue, and it is compulsory, while the access price is agreed between the private parties. When a mutual agreement cannot be'reached, they can use an alternative method of dispute resolution or apply to the regulator, SIT, for arbitration. Regarding the radioelectric spectrum, although the State keeps ownership, the usufruct is 88 auctioned by SIT. So far, seventy auctions have been held, and almost the entire spectrum is in use.89

3.44 The regulatory agency is empowered, in theory, with regulation, arbitration and control functions, but seems to be constrained in their implementation. SIT was created in 1997 with hnctional autonomy from the Ministerio de Comunicaciones, Infraestructura y Vivienda. In order to ensure its independence, SIT was provided with a capital fund and with revenues derived from its enforcement assignments. However, several issues currently jeopardize SIT’S consolidation. First, its capital fund was removed by Decree 47-2002 and now it depends on the public budget. First, the radioelectric spectrum usufi-uct is almost exhausted so no more income can be obtained from its auctioning function. Second, SIT has never exercised its arbitration function to resolve an essential facility dispute, in spite of three well-known recent disputes between operators. Third, although the telecommunication law empowered SIT to sanction anyone who did not obey the law, no such proceedings have been implemented. Finally, although the law enhances the promotion of competition, no function to promote or defend it has been assigned to SIT, and no instruments have been designed to obtain any information about how the market is hnctioning. In brief, the role of SIT is not very clear either as a regulatory agency, or as a control and supervision entity.

3.45 The liberalization ran parallel to the privatization of the state-owned telecommunication firm. In 1997, GUATEL, the publicly owned monopoly was split into TELGUA and GUATEL. TELGUA retained the majority ofthe telecommunications assets and was sold in 1998 to TELMEX, a Mexican telecom operator. Today, GUATEL is a residual entity, in charge of the management and divestment of the remaining assets, debt services, and the operation of some smaller rural telecommunications networks. Today provision of telecom services is hlly private, although investment in rural telephone still is being subsidized.

3.46 Despite liberalization, the fixed telephone sector remains concentrated, while the mobile market is more competitive. Market opening has allowed 15 companies to provide fixed local telephone services, but they account for only 7 percent of the local service market. As pointed out by SIT9’, new operators are concentrating primarily on the more lucrative market segments, such as Guatemala City and other urban areas. Several companies compete in the long-distance market. According to available data on international calls, the Herfindahl-Hirschman Index” (HHI) is 1,800 points, close to

~~

89 A new proposal to amend the law dealing with the use of stolen mobile phones is being discussed at the present time by the Congress. If it is approved, a register of mobile phones will be created and firms should share information about the mobile phone owners with SIT. Guatemalan telecommunication firms are against this new norm. 90 Guatemala has 67 percent of the total number of fixed lines; Quetzaltenango, 5.34 percent; Escuintla, 3.85 percent, and SacatepCquez 2.4 percent. 91 The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between them increases. It can be used to estimate the equivalent symmetric number of firms in an industry. Markets in which the HHI is between 1000 and 1800 are considered to be moderately concentrated, and those in which the HHI is in excess of 1800 points are considered to be concentrated. 89 levels characterizing competitive markets. Regarding the mobile sector, liberalization has brought three new strong competitors into the market to compete with SERCOM PCS Digital, TELGUA's subsidiary: Comunicaciones Celulares (subsidiary of Millicom International, USA); Telefonica Centroamericana Guatemala (subsidiary of Telefonica de Espafia) and Bell South Guatemala, with an HHI of 3,300 points.

Table 3.5: Market Structure of Telephone sector, June 2002 (Lines) percent (Lines) percent Telgua 754,405 93.42 559,992 41.66 Telefonica 24,113 2.99 164,938 12.27 Cablenet 10,974 Fixed Mobile Comcel 6,638 0.82 490,559 36.50 Bellsouth 128,661 9.57

3.47 Rural telecommunications still remain ~nderdeveloped.~~The main unresolved issue in the telecommunications sector relates to the inadequate strategy and institutional arrangements for rural telecommunications. It is estimated that only 5,000 rural communities have access to telephones while 45,000 have no access.

3.48 Because the reforms of 1996-1997 did not address the universal service issue, there are now two institutions in charge of rural telephony, GUATEL and the Telecommunications Fund (FONDETEL). The lack of coordination among them leads to inefficient investments and duplication of efforts93. On one hand, the Government has left the responsibility for operating the original GUATEL's rural phone networks with the new GUATEL, the residual entity. However, the .unclear objectives and roles for GUATEL have led this institution into expanding its own rural telephone network, resulting in inefficient investments, duplications of networks, and the corresponding need for excessive subsidies. On the other hand, FONDETEL was created with proceeds of the spectrum auctions, as a fund to channel subsidies to the private sector to install and operate new rural telephones. FONDETEL's approach is consistent with international best practices as applied in many other LAC countries, such as Peru, Chile or Colombia. By now most of FONDETEL's original funds have already been invested, and no new finding arrangement has been set in place. Its main problem is financing, since no new revenues from the spectrum auctions are expected. Furthermore, its find (Q 49,100,000.0) has been moved to general public accounts by Decree 26-2003. In other countries, the financing is often provided by a small levy (about 1 percent) on all sector revenues. In Guatemala, however, this would require a change of the law.

92 Guatemala: Private Participation in Infrastructure, Implementation Completion Report, SCL-41490, Technical Assistance Loan, The World Bank, June 2003. 93 The World Bank has financed a rural telecommunications strategy study, which identifies the strengths and weaknesses in both GUATEL and FONDETEL and provides specific recommendations for improving the provision of the rural telecommunicationsservices in Guatemala. 90

Electricity

3.49 There has been significant progress in electricity coverage since reforms were introduced. Guatemala started to restructure the electricity sector in the early 1990~~~but performance improved substantially after the new Electricity Law was enacted in 1996. Since then, Guatemala has made rapid, significant progress in electricity coverage. Installed capacity has been increasing steadily from 1,314 MW in 1996 to 1,670 MW in 2002, equivalent to a 27 percent raise. Improvements in efficiency and the implementation of a rural electrification program have resulted in a significant increase in electricity coverage from 53 percent of households in 1996 to 85 percent connected in 2002, the second highest level in Central America after Costa Rica. Coverage is expected to reach levels close to 90 percent in 200495.

Figure 3.15: Electrification coverage Figure 3.16: Central America coverage 1990-2002 ( percent of households)

,e

Source: Comisi6n Nacional de Energia Electrica Source: CEPAL, Eualuacion de diez aAos de reforma en la industria elkctrica del istmo centroamericano, diciembre 2003

3.50 Expansion of distribution and transmission network was subsidized with privatization revenues. The US$114 million paid for two of the distribution companies, DEOCSA and DEORSA, was deposited in a trust fund which, together with a Government and several loans contribution of US$219 million, were used to finance the Rural Electrification Plan (PER). In the DEOCSADEORSA concession areas, the number of clients increased from 650,000 to 1,170,000 between 1999 and 2003 of which 170,000 were attributable to the PER. The average cost of electrifying a rural household has been kept within the US$650 provided by the contract with DEOCSAlDEORSA. Moreover, DEOCSA and DEORSA are responsible for the connection of consumers located within the 200m of the network and have to finance them mostly with their own

94 In 1992, Empresa El4ctrica de Guatemala SA (EEGSA), one of the state electricity companies, was sold in an effort to stimulate private investment and capacity additions that would reduce the chances of supply outages. Private investment was attained through long term power purchase agreements (PPAs) that created stranded cost in the implementation ofthe subsequent market oriented strategy. 95 Comision Nacional de Energia E16ctrica (CNEE), Znforme de Labores 2002-2003, Guatemala. 91

resource^.^^ At the same time, the construction of 420 km of 230 kV transmission lines and 840 km of sub-transmission lines expanded the reach of the power system. Of the total US$333 million, US$183 million will be used to connect new users and US$150 million to expand the transmission grid.

3.51 Improved quality of service. Thus far, increased private participation in the generation business has diminished the risk and occurrence ofcapacity shortfalls frequent in the country in the years preceding the start of the reforms. At the distribution level, although CNEE has issued and monitored the application of several technical norms on safety of electrical installations, quality of technical and commercial services, and the design and operation of transmission and distribution lines, there is little information enabling one to quantify the improvements in the quality of service.97 One of the constraints to distribution network expansion, is the existence of the small municipal companies that have been characterized by inefficient operation and financial difficulties, adversely affecting the quality of service and the possibilities of investment in their respective distribution areas.

3.52 Current tariff policy implies an implicit subsidy from medium size electricity consumers, mainly SMEs, to small and large consumers. Electricity law authorizes large consumers to contract directly with generators or marketers, or buy from the spot market, while medium and small consumers must pay regulated tariffs. The law establishes cost- recovery principles for the tariff setting.98 However, significant stranded costs were created by the Power Purchase Agreements (PPAs) signed prior to 1996. The characteristics of the “existing contracts” - involving approximately 33 percent of all energy produced in Guatemala - account for the high prices associated to the energy delivered by them.99 These high prices are only passed on to consumers subject to regulated tariffs. Further price distortions exist, generated by a generalized social tariff introduced by the 2001 Social Rate Act. The Law establishes a “social rate” at a low price for users consuming less than 300 kWh per month. The limit set is so high that it applies to close to 90 percent of all residential users, and 43 percent ofenergy distributed, thus representing a general subsidy’oo. Supply contracts at social rate levels were tendered for bids and won by INDE public company owning most of the country’s hydroelectric generation resources.

96 Between 40 and 200 meters distance from the existing network, the connection fee is not fixed or capped. DEOCSNDEORSA charge a connection fee that is repaid to the customer over a 5- year period. Below 40 meters, the customer pays a Q60 connection fee. 97 A 25$ IDB loan to DEORSA and DEOCSA approved in 2002 has among its objectives to finance investments geared to improve quality in the energy distribution services. 98 All distribution companies must supply their regulated customers through long-term contracts, trading net balance in the spot market. 99 They lasted approximately 15 years, have a separate price for energy and capacity and originally set very high levels to the minimum amount of energy and capacity that should be paid by distributors, independently of whether they were provided or not. They were subscribed in US$ and were tied to the evolution of the international oil price. After several frustrated attempts, the contracts were renegotiated in 2000 lowering the capacity charge and reducing the obligations to buy the capacity and energy not delivered. In exchange, the duration of these contracts was extended. looLow voltage customers not subject to the social tariff pay between 1.8 and 2.1 times more for electricity. 92

3.53 In relation to Central American countries, Guatemalan medium and small firms pay between 25 percent and 70 percent more for electricity, depending on their size, due to remaining or newly created distortions. Medium consumers finance the stranded costs associated with the existing contracts and also suffer the indirect effects of the social tariffs that are covered by hydro plants, a cheap energy source. These cross subsidies to large and small consumers impose a significant burden to businesses which complain about the negative effects of these high input costs on their competitiveness. This situation is unlikely to be sustainable in the future as demand increases at a relatively high rate and provision of social tariff consumers may not be met in the future with low cost generating sources. Furthermore, the social rate has caused significant opportunity costs for INDE, the public company, and could potentially threaten its financial viability. The political resistance to rate increases and elimination of subsidies, may jeopardize the reform ofthe power sector in Guatemala.

Source: Proceso Demanda EICctrica, CENPE, Instituto Costamcense de Electricidad

3.54 The legal, regulatory and institutional framework is almost completed. The key features of the 1996 sector Law are: (a) unbundling the activities of the sector in generation, transmission, distribution and commercialization of energy; (b) competition in the generation and commercialization activities; (c) unrestricted and open-access to the transmission system; (d) freedom of large energy consumers to choose their supplier; and (e) unregulated generation prices, and transmission and distribution prices regulated according to established and transparent norms. Energy and capacity prices are passed through to consumers and adjusted every three months to account for changes in the exchange rates and oil prices. Network rates are regulated under a price cap system set every five years."' Moreover, the Law created the National Electrical Energy Commission (CNEE) and the Administrator of the Wholesale Market (AMM), which together with the Ministry of Energy and Mining (MEM), constitute the three basic Guatemalan institutions in charge of electricity policy and regulation. The CNEE has a semi-autonomous status; it is technically is part of the MEM, but its budget is financed

lo'The first set of tariffs based on these technical specifications was approved by CNEE in 1998. They were revised by CNEE in 2003 and although, they are currently been applied, they have been appealed to court by business organizations. 93 with the proceeds of a 0.3 percent tax on the electricity sales of distribution companies. In recent years, key regulations ofthe Law and technical norms have been drafted, a law organizing the operation of the wholesale market has been approved and new policies, especially regarding rural electrification, have been developed. After more than seven years of application, the General Electricity Law has generally proven to be adequate for the country’s power sector. There is a need, however, to consolidate the institutional structure created as a result of the reforms.”*

3.55 Actual sector design. According to AMM, in 2003 the wholesale market was composed of 19 generators, 16 distributors, 1 transport operator, 8 brokers and 21 large consumers. Additionally, INDE’s public hydroelectric plants concentrated in the company EGEE - and corresponding to 40 percent of the installed capacity -- the remaining capacity is owned by private companies operating mainly steam and diesel generating plants. Although concentrated in absolute terms, the market exhibits less horizontal concentration than other Latin American markets, and barriers to entry ofnew operators do not appear to be high except for hydro production. lo3The government owns the transmission enterprise (ETCEE). Distribution services are mainly provided by three private companies -- DEORSA, DEOCSA and EEGSA - and serve, the eastern, western and central part of the country respectively. In addition, 13 small electricity distribution networks are owned by municipalities, serving only about 6 percent of the users. The Guatemalan wholesale electricity market is formed by a spot market and a contract market, where energy and capacity are traded as distinct products. The contract market offers a variety of standard contract types in terms of bundling of energy and capacity, price conditions, and other characteristics. In 2002, energy sold in the spot market represented around 15 percent of total energy produced. Generating units are dispatched by “merit” starting with those reporting lowest variable costs. The energy demanded by large consumers (capacity greater than 1OOkW) represents 3 percent ofthe total. Figure 3.17: Electricity Gt :rators and Distributors

Supply Participation Demand participation Source: Comisih Nacional de Energia Electrica.

lo*CNEE is highly vulnerable to legislative changes which could reduce its independence. Also, attention should be given to the hture ofthe entities that still remain in the public sector. Fundacion Solar, Sustainability of power sector reform in Latin America: the reform in Guatemala, Working paper, IDB, May 2002. 94

Logistics: Transport, Ports and Customs

Guatemala Central America Latin Countries with incl. wio America similar GDP per Guate Guate capita * Classified road density 0.13 0.29 0.32 0.16 0.45 (kmikm2) - 1999 Class. Road density 1.3 3.8 4.3 5.2 4.1 (kmi1,OOO people) - 1999 percent paved roads - 1999 35 24 21 24 59 percent businesses satisfied 98 59 51 51 53 I by road quality - 2000 With per capita GDP PPP between 3,000 and 4,000 USD in 1999. Source: World Development Indicators

3.57 The quality of Guatemala's roads is above average. In spite of the limited density, the quality of Guatemalan roads is generally better than regional comparators (though the situation has deteriorated most recently). A significant part of the road network is paved (the highest proportion in Central America, although it remains lower than countries with a similar level of development). About half of the classified unsurfaced road network is in maintainable condition. This quality is widely acknowledged by users. According to a 2000 survey'05, the quasi-entire business community in Guatemala was satisfied by the quality of roads, compared to satisfaction rate of 59 percent for Central America as a whole.

3.58 Overall transport costs and security-related issues. Many factors should contribute to reduced relative transport costs in Guatemala: road conditions are good, reducing vehicles' maintenance costs, gasoline is cheap (the cheapest in Central America), and, apart from a 23 km long highway, there are still no toll roads in Guatemala. However, as illustrated by business surveys, the extremely high levels of crime and insecurity are an issue for logistic costs. As a result, the mean percentage of cargo value lost while in transit due to breakage, theft, spoilage or deficiencies in

IO4 Poverty in Guatemala , Report 24221-GU, The World Bank, February 2003 'Os WBES, The World Bank Institute. 95

(1.65 percent) is slightly above that of CentralAmerica (1.63 percent) despite better relative road conditions.

3.59 The Ministry of Communication, Infrastructure and Housing (MCIV) is in charge of the design and implementation of most road-related policies in Guatemala. In particular, this includes planning for road investments. A national transport plan (Plan Nacional de Transporte) has been prepared for 1998-2015. It has been complemented by a road development plan (Plan de Desarrollo Vial) for 1998-2008. In the shorter term, a 4-year plan is under preparation and should guide investment in the sector for the period 2004-2008. A strategy for rural roads should also be prepared, in partnership with municipalities. Road investments are mostly prioritized according to poverty-based criteria. Overall, national plans are consistent with regional transport plans (e.g. SIECA, Plan Puebla-Panama). MCIV counts with about 5,000 employees, including staff working in regional units.

3.60 A Road Maintenance Fund (COVIAL), created in 1996, is responsible for the maintenance ofthe primary road network (about 10,000 km). COVIAL contracts routine and periodic maintenance as well as supervision to private enterprises and micro- enterprises. The creation of this maintenance fund has contributed significantly to the improvement of Guatemalan roads observed since 1998. However, since 2000, its efficiency has been increasingly affected by significant budget cuts (although the gasoline tax is in theory earmarked for this fund). In early 2003, cuts were responsible for a three-month suspension of road maintenance contracts and a deterioration of COVIAL’s financial situation (due a 100 million Q debt). In addition, due to increased political interference and reduced autonomy, it is estimated that about a quarter of COVIAL’s resources are diverted for road rehabilitation activities (although its mission is to focus exclusively on maintenance). COVIAL is funded by a gasoline tax (one quetzal per gallon) established in 1997 (which has not been updated since then) with administrative costs - 55 staff managing more than 400 contracts annually - corresponding to 2 percent of it.

3.61 The fiscal base constrains investment in public such as roads. In 2002, MCIV’s annual road budget amounted to about Q1.7 billion(US$206 million), including about Q175 million for administration, 4300 million for new construction, 4600 million for rehabilitation and 4600 million for maintenance activities. When adding COVIAL’s resources (see below), in 2002 road expenditures in Guatemala amounted to about 1.3 percent of GDP, which is considered very modest (in comparison, they reach 3.1 percent of GDP in Nicaragua). However, road expenditures represent about 10 percent ofpublic expenditures which is comparable (though in the lower range) to regional and international standards. Guatemala’s low fiscal base is a major constraint to the development of transport infrastructures in Guatemala. Moreover, the significant fiscal adjustments observed in 2000-2002 resulted in a contraction of public capital formation, which has contributed to a deterioration ofthe country’s infrastructures.

3.62 Successful but limited private sector participation in transport. There are examples of private sector participation in all segments of transport activities: construction, rehabilitation and maintenance of infrastructures, and operation of transport 96 services. Construction and rehabilitation of roads are contracted to private enterprises. For the primary network, maintenance contracts are handled by COVIAL, which contracts micro-enterprises (there are about 300 of them) for routine maintenance and larger private enterprises (about 50 are active in this business) for periodic maintenance. Secondary roads are still maintained by state-owned regional units although a new system involving micro-enterprises in the maintenance of non-primary roads was successfully piloted in the region of Sun Marcos. Road transportation services are privately managed. Finally, the only toll-road in Guatemala (Escuintla highway) is also operated under a concession contract. This first example of private participation in road operation is modest (23 km only although an extension is planned) but all stakeholders consider it to be highly successful.

3.63 Significant potential for private sector participation. Several opportunities have been identified for further private sector participation in the infrastructure sector. The Plan Puebla-Panama has listed major infrastructure investments with crucial importance for the region. Projects where private sector participation should be considered including ports (see separate section), airports (six possible sites have already been identified for Guatemala City’s new airport), roads (“anillo perfirico”, toll roads), urban transportation (dedicated bus corridors), and railways. A SIECA study of transportation in Central America has estimated that US$4.6 billion in investment is required over the next 10 years in roads, ports and airports. The study has also identified 10 roads with a traffic exceeding 10,000 vehicles per day, which could be eligible for concession schemes.

3.64 Uncertain regulatory environment. Since there is no concession law in Guatemala (although a project of law has been drafted), the Constitution and a 1985 Ley de contratacion del Estado have been used to provide a legal basis for existing concession schemes in Guatemala. This has resulted in ad hoc legal arrangements in which each concession scheme contract is unique, increasing legal uncertainty. In addition, the fact that each concession model has to be approved by the Congress has brought significant political interference into the process. The impact of regulatory risk on private sector participation in infrastructure in Guatemala has been recently illustrated by two unsuccessful attempts to introduce private participation in postal services or by the difficulties to hlly approve maintenance service contracts for railways. The institution in charge of managing concessions in Guatemala is a unit of the MCIV. With a staff of 6, the institutional capacity of this unit would be clearly insufficient should the number of concessions increase significantly. In addition, past political interference suggests that this unit is not sufficiently autonomous to act as an efficient regulatory body. 97

Box 3.1 : Concession experience in Guatemala

Ports - , operated by a private operator under a 25-year concession, has been ranked the second most efficient and reliable port in Central America. Puerto Quetzal has partial private sector participation in some port activities. Railways - Limited experienced was gained in this sector, with the leasing of railroad equipment, facilities and to a private operator. Roads - A 23 km highway from Palin to Escuintla was constructed by the Government and concessioned to a private company, with an obligation to operate and maintain the road, and to build an additional 22 million USD highway segment. This unusual concession arrangement is considered by the Government to be highly successful. Postal services - In 1997, the postal service provided by the Directorate of Post and Telegraph Services (Direccidn General de Correos y Telkgrafos, DGCT) suffered from over-staffing, an extremely weak financial position and poor and unreliable service. Annual losses were US$2 million. Moreover, small private courier services were using DGCT’s staff and facilities on an informal basis. A five-year management contract with a private Canadian operator was signed and produced significant improvement in the coverage, efficiency and reliability of the postal service. The management contract expired in 2003 and, so far, attempts to pursue it through a concession model have failed. The Government was planning to bid out a 10-year concession, but the bidding process has been delayed due to political opposition in the Congress.

Ports

3.65 Although it has increased over time, Guatemala’s port activity is lower than expected given the size of the Guatemalan economy. Guatemala has five ports but only three are active, Santo Tomas de Castilla and Puerto Barrios (on the Atlantic Coast) and Puerto Quetzal (on the Pacific Coast). Between 1995 and 2002, the tonnage of freight handled in Guatemalan ports has experienced a significant increase (larger than most other ports in the region). This evolution has been particularly favorable for Puerto Quetzal (89 percent), which, in 2002, became the largest port in Guatemala (regarding tonnage). Although they have been diversifying, ports still have strong specificities regarding the types of products which are being handled: containers and crude oil exports in Santo Tomas, bananas exports in Puerto Barrios, sugar exports in Puerto Quetzal. In 2002, Guatemala ports managed 21 percent of the freight handled in Central America ports (ranking second after Panama with 38 percent). However, when compared to the country’s population or size of the economy, port activity in Guatemala is low compared to the average observed in Central-America, for instance Honduras. Limited trade exchanges (which themselves could be constrained by a low efficiency of Guatemala’s ports) provide a credible explanation to the low port activity: when compared to the intensity of trade flows, port activity is at the regional average. 98

Guatemala Central America Including I Excluding I I I Guatemala I Guatemala I Port activity (tons per capita) 1.02 2.15 2.37 Port activity (tons per million USD GDP) 525 863 930 Port activity (tons per million USD trade 1,276 1,249 1,243 flnws)

Source: COCATRAM.

3.66 While Puerto Quetzal is currently saturated, there is unused capacity in Santo Tombs and Puerto Barrios. The two main Guatemalan ports (Puerto Quetzal and Santo Tomus de Castilla) rank 4th and 5th in Central America based on the tonnage, number of boats and number of containers handled (after Puerto Limdn in Costa Rica, Manzanillo International Terminal in Panama and Puerto Cortis in Honduras). In 1999, the occupation ratelo6 was low for Santo Tomus (49 percent compared to 70 percent according to international standards for a 6 berth port) and Puerto Barrios (42 percent compared to 60 percent for a 3 berth port). On the other hand, in spite of a lower number of boats attended (786 in 2002 compared to 1,281 in Santo Tomus), Puerto Quetzal was already saturated with a 81 percent occupation rate compared to 65 percent international standards for 5 berths.

3.67 Although security conditions remain the first concern for logistic enterprises, low efficiency of port operations is also a constraint. As most entrepreneurs in Guatemala, logistics companies are mostly concerned about insecurity and violence problems during port operations but also during transportation. Some container carriers have introduced a security waiver in their contracts while others ask a US$ 100 premium per container to cover security-related costs. Because of insecurity, logistic agents exporting to the Atlantic Coast from El Salvador generally chose to transport containers through Honduras until Puerto Cortis instead of using Guatemalan ports. As a result, it is estimated that the management of 15,000 additional containers have been lost by Santo Tomus. Users usually rank port efficiency as follows: first, Puerto Barrios, in spite of its limited infrastructures (3 berths), then Puerto Quetzal whose efficiency has improved since 1998, and, finally, Santo Tomas where corruption and unreliability problems have been reported. According to the Guatemala Maritime Asso~iation'~~,Santo Tomus' main problems include human resource management, regulatory barriers to the involvement of the private sector and the pricing policy. However, the acquisition of new pieces of equipment and some modernization efforts have produced some (though still limited) productivity gains over recent years in Santo Tomas.

3.68 Sartto Tomhs has a larger staff due to the fact that stevedore activities are still handled internally, while in Puerto Quetzal they are contracted. However, there is some

The occupation rate is one measure of the way port infrastructure is being used. This rate is calculated from the time boats remain on berth, waiting to be loaded /unloaded. lo' Asociacion de Navieros de Guatemala, "Planteamiento para un Efectivo Desarrollo Maritimo y Portuario Nacional", September 2003. 99 indication that the very high level of administrative staff in Santo Tomus is the result of inefficiencies in the management of human resources. Two ports on the Pacific coast do not have a regular commercial activity (Champerico and San Josk) although a concession has been granted to a private enterprise (GRANELSA) to manage liquid products (molasses, hydrocarbons) in San Jose. Some options have been explored to develop Champerico but none have been pursued.

Santo Tomas Pto Pto Quetzal San Champerico Barrios JosC Localization Atlantic Atlantic Pacific Pacific Pacific Number of 6 2 5 These ports berths do not have a regular

Number of I 5 0 2

Management EMPORNAC COBIGUA EMPRESA (State-owned) (Private) PORTUARIA QUETZAL (State- owned) Staff 2,100 (1999) NA 611 (1999) including 60 percent including 45 percent administrative administrat. Source: COCATRAM

3.69 Private sector participation in port activity is still limited but with potential for improvement. Only Puerto Barrios is a private port, the two others are being managed by state-owned institutions (“empresas portuarias”). The only private port (Puerto Barrios) is also perceived by private users as the most efficient; Puerto Quetzal, where some services (stevedore in particular) are under concession and where the use of some infrastructure has been contracted (to ENRON in 1993 and the enterprise San Josk Limitada, in 1997), has become more efficient, while Santo Tomus where private sector involvement is minimal is still considered by users as the least efficient of Guatemalan ports. The lack of a stable regulatory environment (in particular, the lack of a concession law) is a major constraint to hrther private sector involvement in port activities. Where they exist, (such as in Puerto Quetzal) port services concessions have been reported by Guatemala’s Maritime Association as lacking transparency. There is large evidence that the private sector would be interested in being more involved in ports, should significant regulatory and institutional constraints be lifted. In 1998, for example, fourteen private operators had expressed interest in applying for concessions of some pieces of land adjacent to Santo Tomas in order to create a new private port (model used in Panami).

3.70 The institutional framework is characterized by the multiplicity of actors and the lack of a maritime authority. In the absence of a strong and efficient regulatory body, state-owned port operators (empresas portuarias) have become powerful and heavily politicized institutions, reducing opportunities for reform. Control from central agencies on port activities is also affected by the multiplicity of institutions involved. For more 100 than 10 years, the proposition of creating a Maritime Authority has been discussed. It is widely acknowledged than the creation of such an independent body could be a major driving force to foster port reform and increase port efficiency in Guatemala. In addition, port users should be involved in the governance ofports. Currently, the Executive Board (Junta Directiva) ofthe two public ports in operation involves four members representing central agencies (President of the Republic, Ministry of Communication, Infrastructure and Housing, Ministry of Finance, Ministry of Defense) and one member representing port’s workers.

Customs

3.71 The performance of Guatemalan customs has been a systematic bottleneck over the years despite some recent improvement. Five years ago, the performance of the Guatemalan customs was among the lowest in Central-America, according to a 1997 INCAE study. logIn 2000, the business community still had a negative perception ofthe performance of Guatemalan customs, accordingly to the World Bank’s WBES. In 2003, a survey conducted by the think tank CIEN, showed that Guatemalan entrepreneurs still thought that custom regulations were applied arbitrarily by custom officers. *09 Finally, the World Bank 2003 Guatemala ICA’s results indicate that, among the infrastructure variables, customs regulations are the major obstacle to business operation and growth for large enterprises. A modemization process has started recently, as customs have been integrated in the modem and autonomous Superintendencia de Administracion Tributaria (SAT). Custom units are equipped with computers since 2001 (with an on-line system allowing a close monitoring of custom operations and a “workflow-type” management of procedures”’). Collection of customs fees and taxes are made directly by local banks; and a training program has also being implemented through SAT’S training center (CENSAT). As a result, the efficiency of custom procedures has improved: computerization has allowed streamlining 90 percent of custom declarations, meaning quicker and more predictable procedures for users.

3.72 Nevertheless, Guatemala lacks a clear and effective strategy to adjust customs administration and procedures to a trade facilitation objective. Customs were transferred to SAT in 1998, when this institution was created. SAT specializes in tax collection.”’

Io*According to Romero, E. and J. Barahona, Reporte de Seguimiento a la Reforma del Sistema Aduanero de Guatemala, INCAE, June 1997, only about a quarter ofthe custom units had a computerized system (compared to two thirds in El Salvador and 100 percent in Costa Rica) and the proportion of professionals in total custom staff was 5 percent in Guatemala (compared to 12 percent in El Salvador and 21 percent in Costa Rica). The average time to obtain custom clearance (for imports) was 22 hours in Guatemala, 20 hours in Honduras, 19 hours in El Salvador and only 1 hour in Costa Rica. The collection rate per custom employee was also lower: 600,000 USD in Guatemala, compared to 613,000 USD in El Salvador and 968,000 USD in Costa Rica. IO9 Prensa Libre, Informe: Doscientos obstaculos a la inversidn, December 5th, 2003. *loThe Declaracidn Electrdnica de Control Aduanero - Pdliza Electrdnica, has been implemented in July 2000 in Puerto Queztal customs and in 2001 for 14 other customs. Ill SAT was created in 1998, as a decentralized state entity, a status, which gives SAT functional, economic, financial, technical and administrative autonomy. Its executive board includes the Minister of Finance (chairman), four executive directors and a secretary, SAT’S general manager. In 2001, SAT collected 97 percent of Guatemala’s fiscal revenues. 101

Customs is one of the three main departments (intendencias), along with a fiscal department (planning, evaluation and control) and a revenue department (collection and management of fiscal revenues), corresponding to roughly 1/3 of total employees in 2001. Although the initial fiscal collection objectives in custom revenues have not been attained, there was an important improvement: the collection rate per custom employee now exceeds US$1.2 million, a significant increase since 1997. Overall, customs bring a significant share of Guatemala's fiscal revenues (roughly 40 percent), much higher than neighbor countries. Custom revenues have been rapidly increasing since 1996 (at an annual rate of 12 to 21 percent, compared to a GDP growth of 2 to 5 percent).

Water and Sanitation

3.73 Low coverage and poor quality of service characterize the water and sanitation (W&S) sector in Guatemala. Guatemala has huge water resources, but located far from consumption areas. Not only the water coverage is low, but also the quality ofthe service is bad.'12 Interruptions are frequent, and it is estimated that 48 percent ofwater supplied is contaminated. l3 Water purification systems are poorly implemented, in fact, 75 percent of municipalities do not use chlorine in the supplied water. Only EMPAGUA, in Guatemala City and XELAGUA, in Quetzaltenango comply with the quality norms issued by COGUANOR (NGO 29001). Table 3.10: Water and Sanitation Service Coverage Rural Urban Total household connection 33.6 48.8 44.0 58-65 88.0 78.9 91.3 97.0 49.2 67.3 92.0 Access within 200 m 22.4 46.1 20.1 11.7 5.2 18.7 28.3 No Service 44.0 5.1 36.0 35-42 12.0 9.4 3.5 3.0 32.1 4.4 8.0

Sanitation Services ( percent) household connection 4.2 48.8 16.0 40-45 - 93.3 64.3 - 34.9 28.6 - Access within 200 m 56.3 46.1 58.0 - 2.1 33.5 - 37.6 56.6 - No Service 39.5 5.1 26.0 55-60 - 4.7 2.2 - 27.5 14.8 -

3.74 Guatemala has the lowest water rates among Central America countries. Water prices vary across the country, depending on the municipality, the community, and the infrastructure cost of supplying water. The Water Bill under discussion empowers the regulatory body with the responsibility of regulating the tariff system. Guatemala would have enough water to support its economic growth and to meet the needs for the next years, but it is badly allocated. Water is used inefficiently in the agricultural sector because of lack of knowledge about more efficient irrigation methods. Artificially low rates do not provide incentives for more rational consumption habits.

'I2 The impacts on health are well known: not surprisingly, Guatemala has the highest diarrhea rate for children under five years old. II3Asreported by the 111 Encuentro de Poblaciones Indigenas sobre Agua y Saneamiento. 102

Table 3.11: Water rates in Central America (US$) Nic aragu El Salvador Honduras Costa Rica Guatemala* a H/C/R H C I H C I H/C/R H C I Standard Consumer (1 5 m3 2.6 3.2 11.4 16.5 1.5 10.9 33.2 3.7 3.9 14.2 22.1 Standard Consumer (30 m3 5.3 7.5 11.4 16.5 3.2 16.5 40.6 11.7 8.6 26.7 41.6 Standard Consumer (50 m3 10.3 - - 16.5 20.2 31.8 51.1 19.3 21.8 42.6 67.6 H: Household, C: Commercial, I:Industrial; (*) Rates charged by EMPAGUA in Guatemala City Source: Calculations, based on SIECA, October 2003

3.75 Private sector involvement is low and mainly present on urban W&S systems. Since 1972 EMPAGUA has been the municipality firm in charge of providing water and sewerage service to Guatemala City. Apart from the water supply, EMPAGUA is in charge of designing developing plans and policies for the expansion of service to everyone living in and around the metropolitan area. Currently, EMPAGUA is serving 85 percent of demand in Guatemala City, while AGUAS DE MARISCAL, a private firm with a concession from the 1950s, supplies 10 percent. There are some small private firms, usually real state owners, who build their own infrastructure and distribute water from wells, independently of the public supplier or the concession holder. They supply the remaining 5 percent. EMAX (Empresa Municipal de Aguas de Xelaj6) is working in Quetzaltenango, and EMAPET in three municipalities in Peten.

3.76 In some communities, citizens organize themselves in committees, usually for two years, and are authorized by the municipality to build and operate water and sanitation systems. Committee members are allowed to collect small contributions from the communities they serve, and they may be responsible for operation and maintenance. Alternatively, they may pay someone from the community to operate the system, usually on a part-time basis. Some people consider this mechanism a “private service” and therefore subject to the Civil Code. Moreover, the Instituto de Foment0 Municipal (INFOM), created by decree in 1957, and the Unidad Ejecutora del Programa de Acueductos Rurales (UNEPAR), former independent institution now integrated within INFOM as a directorate, give technical and financial support to communities interested in having water access, but never act as suppliers.

3.77 Guatemala lacks coordination and suffers inefficiencies in the performance of institutions in charge of regulating the water sector. Planning, regulation and management are performed by a number of institutions. Five different governmental institutions are involved in planning.”4 In turn, regulations dealing with issues of public health and environmental protection are not clearly assigned to any institution, except to the Ministry of Health (MSPAS), who has national responsibilities on the quality of water. Finally, management hnctions are shared among metropolitan, urban, and rural entities. The municipalities have the legal responsibility to provide water and sanitation services to everyone living within the urban or rural areas, according to the new Municipal Code published in May 2002. Water and sanitation services can be directly

‘I4 Namely the General Secretary of Planning (SEGEPLAN), the Institute of Municipal Promotion (INFOM), the Ministry of Agriculture, Livestock, and Food (MAGA), the Ministry of Public Health and Social Assistance (MSPAS), and the Environmental Secretary (CONAMA). 103 provided by a municipality as a “public service,” by a group of municipalities organized as “mancomunidades” or assigned by concession, with Congress’ approval, to other providers. In all cases, tariffs have to be approved by the municipalities. Because several institutions are responsible for water and sanitation, lack of coordination has resulted in inefficient performance.

3.78 Guatemala also lacks an unified and consistent regulatory framework for water and sanitation systems. There is no sector regulation that specifies objectives and determines which institutions should implement them. The basic legal framework is scattered in the Constitution (1985), the Cddigo de Salud, the Codigo Municipal (2002) and the Acuerdo Gubernativo 376-97 (1997). A Water Bill, called Ley de Agua Potable y Saneamiento, has been under discussion in Congress since 1996, the last draft dated on March 2002. Meanwhile, the Government has tried to reform this sector by alternative means. Thus, in 2000 it created the National Commission in charge of the reform and modernization process for water and sanitation that has not made much progress.

Box 3.2: The Modelo BBsico After limited reform was undertaken to integrate institutions and to rationalize programs and capacities, some new initiatives have been carried out. Regarding the rural reform, in June 1998, INFOM, helped by OPS, UNICEF, and IDB prepared a formal proposal with the document called Modelo Basico. The objective ofthe project was to homogenize and to standardize the actions on rural water and sanitation implementations. Three broad questions were covered by it: technical matters, legal and financial administration, and social scope. This model can be applied to new projects, extended projects and rebuilding projects, and the challenge is to recover all or partial investment, or at least, the maintenance costs. In addition, it seeks to use efficiently the institutional capacity, basically in INFOM, municipalities and MSPAS. On the other hand, the community has to be intensively involved, in order to guarantee the success and sustainability of the project. Modelo Bhsico stresses the promotion of integrated projects covering potable water and sanitation; the signing ofa tripartite agreement between the communities’s Water Committee, the municipality and UNEPAR; and the sustainability based on greater community participation. Modelo Busico also calls for tariffs that cover operation and maintenance costs, as well as contributions towards a fund for replacement and extension. Some projects based on Modelo Bdsico have been successfully finalized and others are ongoing. The Instituto de Foment0 Municipal declares that most of the loans awarded to local communities are at least partially recoverable. For instance, the PAYSA project, funded by USAID, made funds available to rural communities in highlands, and despite the fact that these communities are among the poorest in the country, over 80 percent of the total amount has been recovered. This amount would have been higher, had UNEPAR been more efficient in collecting the loans back. 104 I Box 3.3: Rural Infrastructure Following the 1996 Peace Accords, the pace of new connections to water, electricity and sanitation services increased significantly from 80,000 new connections per year for each service, in the period 1993/6, to 115,000 new connections per year in the period 1997101. The volume of social fund resources channeled towards rural infrastructure programs increased from US$17 million to US$152 million in the same time interval. Moreover, a further US$120 million of privatization proceeds were earmarked for rural electrification and telephony. As a result of the greater volume of resources devoted to service expansion, households in traditionally excluded sectors -the poor, rural, and indigenous populations- were twice as likely to be the beneficiaries of a new infrastructure connection than they had been in the period from 1993-96. However, this disproportionate gain has not been enough to compensate for the lower initial probability ofbeing connected for members of these traditionally disadvantaged groups. Notwithstanding the significant progress made, the achievement ofuniversal access to modern utility services is likely to take Guatemala a further 8 to 10 years, as estimated by Foster and Araujo (2001).1’5 The situation, as portrayed by the ENCOVI 2000 survey, is summarized in Table 12. Sanitation, broadly defined, is the service with the highest level of coverage, followed by electricity, water, sewerage and telephony. The gaps between urban and rural coverage are highest for sewerage and telephony. Sewerage and telephony are those with the least egalitarian distribution.

I Public Tel I .64 I 39 I .44 I .37 I .53 I .65 I .79 I .83 Source: Foster and Araujo (2001).

Depending on the service, 20 to 40 percent of the coverage gap is related to purely demand side factors and could be resolved without major investments in network expansion (since service is already available in the community where those not connected households live). Between 10 and 50 percent ofthe coverage gap, depending on service, would require both physical expansion and demand-side measures. Connection charges for most services may represent a barrier for lower income households, since they amount to a substantial proportion ofthe monthly poverty line. In electricity, the social tariff reaches 100 percent of poor households with electricity connections, but only 40 percent of poor households enjoy these connections and hence benefit from the subsidy. Given that households without electricity pay 75 to 150 times more per kWh of lighl using dry cell or car batteries, the cost effectiveness of the social tariff policy could be significantly improved by reducing the consumption threshold levels and financing ne- connections with the saved resources. Other infrastructure policies may also be revised, speciallj by taking into account that connections to modern utilities bring significant time savings to rura households, and have a substantial impact on the profitability ofhome based micro-enterprises.

‘IsFoster, V. and C. Araujo, Does Infrastructure Reform workfor the Poor? A case studyfrom Guatemala, Background Paper for the Guatemala Poverty Assessment 2002, December 2001. 105

VI. Financial Sector Development 3.79 The financial sector is a potentially important source of growth for Guatemala, both from a macroeconomic and a structural viewpoint. From a structural viewpoint, there are good conceptual reasons, supported by a strong body of evidence, for believing that financial market development exerts a strong influence on economic growth.’16 In particular, access to finance is critical to facilitate the implementation of profitable productive projects which may otherwise remain unrealized. An efficient and competitive system that provides efficient services for savers and channels resources to productive projects is essential for growth. From a macroeconomic viewpoint, the costs and disruptions caused by banking crises are found to exert an impact on stability and growth. Avoiding crises, such as the one experienced in Guatemala in the late nineties, would go a long way towards ensuring a more conducive environment for sustained growth.

3.80 Despite progress since 1990, Guatemala continues to display low levels of financial depth in international comparisons. The level of financial depth, measured by the volume of credit to the private sector, rose from 12% during the crisis year of 1990 to about 20% in 2003 (Figure 1). However, the latter level is low in comparison with other countries in Central America, where the regional average is 33% (Table 1). The assets of the banking system, the mainstay of the financial system in Guatemala, are strikingly low (only 26.6% of GDP) in comparison to the regional average (over 50%).”’ The low coverage is particularly alarming in the rural areas.

Figure 3.18: Credit to Private Sector (YOof GDP)

25 1 7

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

‘I6Extensive documentation on the conceptual reasons and empirical evidence linking financial development and economic growth is given in Levine, Ross (1997), “Financial Development and Economic Growth: Views and Agenda,” Journal of Economic Literature, June, 35 (2), pp. 688-726. ’” It is important to note that these figures exclude the off-shores, which account for approximately another 30 percent of assets. The off-shores are now, under the new laws, being incorporated in the Guatemalan data and should give a better measure of comparison with other countries. 106

Table 3.13: Banking Systems in Central America, end-2003 (In percent, unless otherwise indicated) Assets Assets Credit to private Deposits Real Interest (US$, relative to sector relative to relative to lending rate bln) GDP GDP GDP rate 31 spreads ?I Costa Rica 8.2 56.9 36.0 43.4 16.1 15.2 El Salvador 9.8 68.7 49.6 42.7 4.4 3.2 Guatemala 6.5 26.6 18.0 22.1 9.5 10.2 Honduras 4.0 59.3 37.6 43.1 13.1 9.3 Nicaragua 11 2.1 56.9 26.4 41 .O 9.2 9.9

Average 6.1 53.7 33.5 38.5 10.5 9.6 Source: IMF, International Financial Statistics (IFS). 11 Data for El Salvador, Costa Rica, and Nicaragua relative to GDP are for 2002., 21 Total of claims excluding fixed and other assets. 31 The real lending rate is calculated as the average lending rate reduced by CPI inflation.

3.81 Guatemala’s banking system appears to be yielding returns that are only slightly below regional averages (Table 3.14). Lower returns seem to be the result of recent measures taken to improve provisioning and capital adequacy standards. However, part of the lower returns may be more structurally related to administrative costs, which are somewhat higher than the average in Central America.

Table 3.14: Selected Banking Sector Indicators in Central America, 2003 1/ (in percent) Net Provisions1 Admin.costs ROAE ROAA Worth NPLs 21 IAve. Assets /Assets Costa Rica 11.3 168.1 5.9 17.5 1.9 El Salvador 9.4 129.1 3.2 11.4 1.o Guatemala 18.5 92.6 6.8 12.6 1.6 Honduras 9.0 47.6 6.4 10.9 1.o Nicaragua 17.2 181.3 7.4 26.6 3.4 1 Average 13.1 123.7 5.9 15.8 1.8 Source: Fitch-IBCA. 11 Data is as of September for Honduras, and as of December for the other countries. 21 Banks are required to provision according to the quality classification oftheir loan portfolio and not only according to their level of NPLs, which explains the high coverage for most countries.

3.82 A key challenge facing Guatemalan policymakers is to reduce the financial sector’s vulnerability to shocks without inhibiting its development. This is a challenging task because the objectives of reducing the vulnerability to crises and deepening the sector may conflict with each other in the short term. Reducing vulnerability usually implies the adoption of conservative financing rules and tighter application of prudential norms, which can limit the rate of credit expansion in the short run. In the long-run, however, well designed and applied prudential norms and solid regulatory institutions provide a more lasting foundation for sustained growth. 107

Market Structure and Performance

3.83 The formal financial system in Guatemala is dominated by banks operating at the center of financial conglomerates. The financial system consists of the Central Bank, 28 commercial banks (including one branch of a foreign bank and one majority foreign- owned bank), and 18 nonbank financial intermediaries. Total assets of banks add up to 36 percent of GDP. Three banks have some Government ownership representing only 14% of banking system assets: CrCdito Hipotecario Nacional de Guatemala, Banco de 10s Trabajadores and Banco de Desarrollo Rural. Two banks have majority foreign ownership, but they only represent 5.9% of the banking system assets. The regulated financial system also comprises foreign exchange houses, warehouses, insurance companies, and “bonding” companies. Banks dominate the scene, accounting for almost 91 percent of the regulated system’s assets, followed by financial companies (5.2 percent). However, the large amount of intermediaries suggest that the Guatemalan system may be over-crowded and in need ofconsolidation.

3.84 Banks are usually at the center offinancial conglomerates in Guatemala. A typical large financial conglomerate centers around an onshore bank, linked to an offshore bank, a financial company, an insurance company, a securities broker, and companies engaged in leasing, factoring, credit cards, and warehouse businesses. Most of the large financial conglomerates are embedded into broader economic, family-dominated groups, which highlights the need for tight coordination in supervision of the financial and productive sector.

3.85 There is also a large unregulated system of financial transactions in Guatemala, estimated to be roughly similar in size to the regulated one. This system includes leasing, factoring, and credit card companies. In addition, a proper securities market does not exist in Guatemala and the securities transactions that do take place are a reflection of a repo-based money market that mainly involves banks.

3.86 With the eight largest banks accounting for 75 percent oftotal assets, there are no overt signs of undue market concentration.‘18 Interest rate spreads are reasonable, slightly above those in Honduras and Nicaragua, below the level in Costa Rica, and only significantly superior to those exhibited by El Salvador (Table 1). With an open capital account, larger companies have also benefited from access to external finance, particularly from financial institutions based in El Salvador. However, the situation is different for smaller businesses and rural-based clients, who have little or no access to formal credit and, when they enjoy such access, may face only one potential formal lender in many areas ofthe country.

3.87 Access to finance remains one important complaint among entrepreneurs in Guatemala. A recent survey undertaken by the World Bank on the Investment Climate revealed that most of the credit is on a short-term basis, with very low levels of long term lending. The reason for that may be twofold. On the one hand the conservative approach of banks, and low competition in the banking sector, prevents long-term lending, crucial

lisBy way of contrast, in El Salvador only four banks control over 80 percent of assets. 108 to sustain growth in the economy. On the other, small businesses do not possess the collateral and sometimes the managerial skills to draft sound and solid business plans to present plausible financing requests to banks. Moreover, banks find it difficult to make risk analyses and credit judgments also due to inadequate accounting and financial reporting, especially by SMEs. In addition, effective loan rates (interest rates plus service rates) have declined very little or not at all, suggesting an increase in service rates.

3.88 Access to formal credit in rural Guatemala is low, despite high repressed demand. In 2000, a national rural household survey revealed that about 40% of rural households wanted to receive credit but chose not to apply. The most important reasons for not applying for a loan were: (i)lack of (formal) collateral; (ii)costly terms; and (iii)fear of ineligibility for a loan. Of those who applied, only 13% actually received a loan (15% among the non-poor and 13% among the poor). In the same year, just 10% of landless households applied and received a loan as opposed to 15% for landowner households, indicating the importance of collateral. On the supply side, coverage of formal credit institutions appears to be fragmented and low outside of major and secondary cities, at least previous the recent Banrural branch expansion. Half of the households that reported receiving loans in the ENCOVI survey obtained them from informal moneylenders which charge from 10 to 20% per day.

3.89 Guatemala has achieved significant outreach in the micro-finance sector. With data from national networks Guatemala comes out above El Salvador and Honduras and below Guatemala in terms of number of offices, active loan accounts and loan portfolio (Table X). The market is characterized by a focus on group methodology and unusually long loan terms (examples include terms of six to twelve months, even for commerce activities, with monthly payments of interest only and a balloon payment of principle at the end of the period).”’ Banrural, a public-private ownership bank as a result of agreements included in the Peace Accords, focuses a significant share of its lending to microfinance, for which it has increased rapidly its infrastructure from 90 branches in 2000 to over 250 by late 2003. Created in 2001, REDIMIFI2’ is the new national microfinance industry association. By the end of 2003, its 20 affiliates had a combined infrastructure of 131 offices and branches, and a loan portfolio of about US$35 million serving 97,000 clients, with about 70% of the portfolio situated in rural areas.12’ In addition, by the end of 2003, the Federacion Nacional de Cooperativas de Ahorro y Credit0 (FENACOAC) had a membership of 26 credit unions, some 348,000 members (of which a quarter to a third are users of micro finance) and a loan portfolio of $145 million.

119 Findley,. Andrea L. and Martha Maria Salgado, “Microcredit in Central America, A Market Study”. Katalysis Partnership. Data collected May-June, 2000. IZoRed de Instituciones de Microfinanzas de Guatemala 12’ Self reported data from Web site. Definition of “rural areas” may vary between institutions. I

109

Table 3.15: Microfinance Industry in Central America

Country Industry No. of No. of offices No. of active Loan Association affiliated loan accounts portfolio MFIs (US%) Nicaragua ASOMIF 20 147 150,025 59.8 Guatemala REDIMIF 20 131 97,000 35.0 El Salvador ASOMI 6 24 25,000 13.0 Honduras COVELO 21 100 15.000 32.0

Source: World Bank, Nicaragua Broad Based Access to Financial Services Project PAD, 2003.

3.90 There is a need to improve the systems of smaller, local MFIs that are not a part of the REDIMIF network, and the need for increased information and assistance geared towards commercial bank downscaling. To promote fbrther outreach ofits micro finance sector, Guatemala needs to develop credit information systems to reduce the high operational costs ofmicro-finance institutions.

Legal and Regulatory Issues

3.91 Guatemala has made important progress in modernizing and liberalizing the financial sector for over a decade. Beginning in the early nineties, the authorities liberalized interest rates, allowed the exchange rate to float, and later improved the independence of the Central Bank, standardized reserve requirements, eliminated compulsory lending, introduced a deposit guarantee, and improved supervision. These policies have gradually facilitated the entry of new banks and other financial intermediaries, along with the merger and acquisition of banks, and substantial broaden!ng ofthe market.

3.92 The banking mini-crisis of 1999, although triggered by external shocks such as declining coffee prices and the effects of Hurricane Mitch, was the result ofthe volatility of macroeconomic policies and the institutional weaknesses in the financial system. The crisis generated a sharp increase in bad debts in bank loan portfolios that had to be covered by higher provisions. The crisis demonstrated the vulnerable position of the financial sector and highlighted the absence of a speedy and efficient resolution process for troubled banks, which is essential for containing the spread of banking crises and limiting their fiscal cost.

3.93 The mini-crisis of 1999 demonstrated the need to embark on fbrther reforms. It demonstrated the need for strengthening consolidated supervision (including financial conglomerates and off shore affiliates), for introducing controls on connected lending, and the need to regulate off-shore operations. Motivated by these events, new legislation was approved between the end of 2001 and mid-2002, which thoroughly modernized Guatemala’s legal framework in the financial sector and, most significantly, substantially enhanced the powers ofthe regulatory and supervisory agencies. The new framework: (i) enables the consolidated supervision of financial groups, including off-shore affiliates; (ii)establishes stricter prudential standards, including an increase in the required ratio of 110

capital to risk-weighted assets; (iii)increases the minimum capital required to establish new banks; (iv) establishes strict guidelines on terms of loans to related parties to avoid special treatment, as well as a limit on such loans (30 percent of total bank equity); (v) creates an explicit, limited deposit insurance scheme; (vi) improves prompt corrective action rules to deal with troubled banks and strengthens bank failure resolution powers significantly; (vii) strengthens prevention and detection of money laundering activities; and; (viii) gives the banking superintendency enhanced supervisory and sanctioning power; specific functions and a greater autonomy; and legal protection for staff for actions taken in the discharge of their official duties.

3.94 The legislative package was also complemented with a new Central Bank Law and a new Monetary Law. The first made price stabilization the policy objective of the Banco de Guatemala, and required the central government to cover the bank’s past and future losses. The second upgraded the framework to facilitate foreign exchange convertibility, capital mobility, and domestic intermediation.

3.95 Application of the new legal framework has already yielded an improved financial system. In particular, onsite inspections of onshore banks, conducted over the past two years have led to a noticeable strengthening of capital and provisions. The bank superintendency has used its new powers to require banks to constitute adequate reserves for non-performing or doubtful loans. As a result, the financial condition of the banks is stronger, which now have average capital adequacy ratios above 15 percent and non- performing loan ratios below 8 percent (See Table 3.16). In addition, the new strategies to deal with troubled banks is already evident, as seen in the important decision to intervene, pay off fully the depositors, and begin legal procedures to close three small banks in 2001.122 The old strategy of providing emergency loans from the Central Bank and reassigning deposits from the public sector to banks suffering from liquidity and solvency problems has been sharply reduced.

June 2002 June 2003 Capital Adequacy Capitalhisk-weighted assets 14.4 15.1 Non-performing loansitotal

rLiquidity Liquid assetshotal assets 28.2 29.9 Liquid assetshhort term liabilitier 31.9 32.7 Foreign currency loans/total loan: 22.5 25.5 Foreign currency liabilities/ Total liabilities 15.5 17.8

12’ The only decision which is not in full accordance with the new framework was the takeover by Credit0 Hipotecario Nacional in March 2003 of two troubled medium-sized banks (the state-owned Banco del EjCrcito and Banco del Nor-Oriente) which held a combined 2.5% of banking system assets and 0.5% of deposits. The Government capitalized CHN with $20 million and is committed to further capitalize it with $25 million in 2004. 111

3.96 To obtain maximum benefits from the new framework and ensure the continued deepening of financial markets in Guatemala, progress in putting in practice new legislation needs to continue. Key actions include:

Complete the process to permit comprehensive supervision of the system, including offshore institutions. Complete the process of licensing financial conglomerates and offshore banks. Issue the pending regulations on bank resolution to make the new framework operational. The main elements of the new resolution framework are: (i)a trust fund that will securitize the performing assets of failed banks; (ii)a fiduciary fund that will help finance mergers and acquisitions of financial institutions (FFBC); and (iii)a deposit insurance fund (FOPA). Capitalize the fund (FFBC) that would provide assistance in mergers and acquisitions of medium to large banks. For this fund to be effective in facilitating the consolidation process, taxes must be eliminated from the financial transactions involved in bank consolidation and resolution Strengthen the bank safety net. This requires funding the deposit insurance fund (FOPA) aimed at covering the insured deposits of important banks, and limit the use ofthe central Bank’s liquidity for intervened banks. Complete the process to recapitalize the Central Bank which requires congressional approval for a long-term zero-coupon bond to be issued to cover central bank losses accumulated up to end-2001 and transfers from the budget to recognize losses incurred in more recent years. Eliminate undue restrictions that reduce the scope for financial services. Examples of these restrictions include the cap introduced in 2003 on interest rates charged by interest card issuers, and the limits on fees to finance the transfers of funds from abroad.

3.97 Deepening financial sector development will also require overcoming other important obstacles in the form of a highly politicized judicial system and a deficient legal and institutional framework. Key components of the judicial system are still weak, which implies that judicial decisions are often correlated with the relative power of the litigants. This has allowed for the rapid growth in retail banking services over the last three years, starting with credit cards and extending into car loans and house mortgages, but it makes commercial lending very risky, particularly to large local corporations and influential individuals. In executing judicially a real guarantee, the relative power of the litigants often decide the contest. This has the consequence that banks limit themselves to granting credit and taking real guarantees from counterparts that they expect to be able to defeat in court, rather than the potentially most profitable investment opportunities. This constitutes a clear limitation on the efficiency ofthe financial system.

VII. Policy Recommendations

3.98 Almost a decade after the implementation of the Peace Accords, impressive results were achieved in the provision of infrastructure services, especially in terms of 112

expanding coverage. However, much progress remains to be made in order to improve Guatemala’s overall state of governance - particularly in terms of improving the rule of law, and reducing crime and corruption rates. This would suggest a certain emphasis on this group of variables when compared to infrastructure issues. In this regard, one note of caution is recommended: as governance issues may require large efforts to generate direct impact on firm-level productivity, it might be desirable to combine such initiatives with measures that may have a higher impact, such as customs reform. In the remainder of the section the recommendations are detailed.

3.99 Although some important corrective actions have been made to overcome the last Property Registry crisis, now the main challenge of embarking on structural reforms must be a top priority if credibility in the registration process is to be restored. The center of a new reform process at the Registro General de la Propiedad should be the merger of the cadastral and registry functions, either in the context of the existing draft law for the creation ofthe Registro de Informacion Catastral, or as part ofa new Registry Law.

3.100 A comprehensive strategy for combating crime and violence in Guatemala should encompass the following key elements: (i)with regard to the National Civil Police (PNC), it is necessary to provide adequate financial resources to confront crime professionally, to increase the number of PNC officers and to accelerate the process of revising legislation goveming this institution; (ii)with regard to the Office of the Prosecutor, budgetary shortfalls must be addressed, and additional material and human resources should be assigned to investigate crimes and to protect prosecutors and witnesses; (iii)with regard to the Judicial System, it is important to implement measures that guarantee its financial sustainability and to accelerate the implementation of the National Policy to Combat Crime; (iv) in all three institutions it is essential to define a strategy to fight corruption; (v) it is also critical to correct the lack of coordination of criminal investigations between the Office of the Prosecutor and the PNC; (vi) better legislation and enforcement of regulation for access to firearms and for the private provision of security services may help to reduce risk factors; and (vii) the quality of the data has to improve, from official institutions and victimization surveys, so as to identify the groups that are most at risk and to define preventive measures. In Guatemala, the available statistics make it difficult to quantify the magnitude of the different forms of violence and to study their evolution. Even basic indicators of crime, such as the number of homicides, show important disparities between different official data sources.

3.101 In the telecommunications sector, progress achieved so far could be sustained and improved by initiatives in the following areas: (i)improve regulatory governance and

_I power of regulatory agency, especially to oversee anti-competitive strategy by dominant firms and (ii) improve mechanisms for private participation in rural telephone infrastructure.

3.102 In the electricity sector, policy actions for the electricity sector in Guatemala in the next few years should: (i)reconsider the definition of the social tariff, in order to target exclusively the most economically vulnerable people; (ii) fine-tuning the regulatory framework, especially to provide incentives for long term investment and efficient energy use; (iii) push forward the Public Expenditure Review (PER) 113 implementati~n’~~and formulate further decision and financing mechanisms to allow for on- and off-grid solutions to provide electricity to the remaining households without electricity; and (iv) devise mechanisms to increase access to productive uses and micro- finance services so as to allow customers to generate income through the use of infrastructure services such as electricity.

3.103 In the transport sector, access is a key issue, as the country is predominantly rural and the urbanization process is exceptionally 10w.I~~In this area, plans to extend coverage must be drafted within a strategy aiming at strengthening rural-urban linkages and developing trade corridors. Another issue is the impact of fiscal adjustment on resources for road maintenance: minimum maintenance levels should be kept to avoid excessive deterioration and associated higher recovery expenditures. One alternative would be to secure fbnding for COVIAL and make it an autonomous institution to avoid political interference. Planning capacity at both central and local levels is desirable. Also, reducing regulatory risk would allow private sector participation in construction, operation and maintenance. For that purpose, implementation of a suitable regulatory framework (concession law) and institutional capacity (independent concession unit) might be necessary. CI

3.104 In the port sector, policies should center on two key priorities: (i)reduce political interference in publicly administrated ports through improving user’s participation in the executive boards; introducing financial discipline; and modernizing management process in public ports with due attention paid to human resource management, productivity and transparency (if privatization is not feasible) and (ii) implement regulatory and institutional reforms to facilitate private participation, perhaps starting with port extension (e.g. in Puerto Quetzal due to a saturation problem).

3.105 Customs reform should focus on two main priorities: (i)implement a custom reform strategy to improve trade facilitation, possibly through the implementation of the Central American customs union; and (ii)reinforce the credibility of customs by finalizing the modernization process, intensifying training, and implementing quality- based management (perhaps considering an IS0 9,000-certification -- as in the case of INTECAP).

3.106 In the water and sanitation sector, the legal and institutional framework should be reformed in order to clarify the roles of the different government institutions. The Water

Disagreement over compensation ofthe PER trustee fund jeopardizes completion ofthe PER, as a US$89 million loan with the Inter American Development Bank will not be processed unless amendments to the Trust Fund Agreement are made. 124 Over the past decade, the share of urban population has evolved from 38 percent to 40 percent, compared to 45 percent and 55 percent for Honduras or 52 percent to 62 percent for El Salvador. In addition, the primacy rate is also very high: in 2000, 72 percent of the urban population was living in the capital city (compared to 35 percent for El Salvador or 28 percent for Honduras). This means that secondary cities are underdeveloped in Guatemala. Urban concentration is mostly happening in the capital city, where inefficient urban transportation is a bottleneck to the development of the urban economy. The urban economics literature stresses the importance of secondary cities to foster economic growth. See Henderson, V., The effect of Urban Concentration on Economic Growth, WP 7503, National Bureau ofEconomic Research, 2000. 114

Bill under discussion - that defines the Instituto Nacional de Agua Potable y Saneamiento, as the policy maker, the Comision Nacional del Agua Potable, as the regulatory body and relies on public, private or public-private suppliers for the provision of services - seems to be well designed. If passed, it will reduce uncertainty -by assigning the responsibility to the Comision Nacional de Agua Potable to allocate the concessions-, it will increase transparency in the sector, and it will clarify the role of private involvement. This issue is more relevant in urban and industrial areas where potential economic growth is larger, than in rural zones, where public fbnding may be required to improve the access to water and sanitation systems. In rural areas, support to projects under Modelo Basico seems to be an appropriate course ofaction.

3.107 In the financial sector, recent reforms to strengthen the sector should be fully implemented. This requires the redoubling of efforts to effect onsite inspection of the offshore banks; the licensing of a number of financial conglomerates and offshore banks; making the bank resolution framework operational, including removal of valued added taxation to financial transactions associated with mergers or acquisitions; pursue other legislation that is pending and important to complete the reforms include those related to non-bank financial intermediaries and secured transactions. Another important objective is to widen access to finance, with emphasis on the rural sector where presence of formal institutions is less visible and where problems with collateral impede access. Measures that could assist the expansion of rural finance include the approval by Congress of the draft laws on the Cadastre and Property Registration, and on Secured Transactions, along with an acceleration of the cadastre program and the modernization of the Registry. Additionally, the micro-finance market could benefit from a more transparent system and be transformed from unsupervised micro-credit to supervised micro-finance institution status. Chapter IV. Technology Performance and Policy in Guatemala

I.Introduction 4.1 Guatemala’s record of economic growth and slow progress in poverty alleviation over the last decades is closely associated to its low levels of investment and its low rate of total factor productivity growth (TFPG), as explained in Chapter I. Due to the importance of TFPG and technical progress in the explanation of differences in long-term growth across countries, this chapter focuses on technology and innovation in Guatemala and argues that this is an important front that requires attention in the agenda to raise the hture rate of growth in Guatemala. 12’

4.2 Low levels of TFPG can reflect problems in technological performance, obstacles to the reallocation ofproduction factors or slow improvement in their “quality.” More broadly, TFPG growth may also be affected by critical policies that serve to boost growth in the long run. This chapter focuses on Guatemala’s poor technological performance, reflected in its poor capacity to absorb and diffuse internationally available technology and, more broadly, to innovate. Obstacles in the process of factor reallocation are addressed more broadly in chapters I11 and V, in which the impact of the investment climate and the trade regime on resource allocation in the economy are discussed. The “quality” of labor is the subject of chapter 11. Issues related to the “quality” ofcapital are also discussed in this chapter.

4.3 This chapter evaluates where Guatemala stands in its capacity to absorb and adapt new technologies and innovate. This capacity is related to the availability of appropriate inputs and to the economic incentives to use these inputs efficiently. The way public institutions and private firms react to economic incentives and interact among each other to combine the available inputs defines the National Innovation System (NIS). Because technology absorption and innovation involve several market failures, a well designed technology and innovation policy is a key component of a well-performing NIS. The objective ofthis chapter is to assess the efficiency of Guatemala’s NIS as well as the main obstacles for its improvement. Policy alternatives are also discussed. The chapter is organized as follows: section 2 reviews indicators of innovation performance, section 3 investigates determinants ofperformance, emphasizing the availability of inputs, the structure of economic incentives, and the linkages between the public sector and private firms. Section 4 discusses some policy alternatives and the final section presents a summary offindings.

11. Technology Absorption, Diffusion and Generation 4.4 Guatemala’s relatively low integration to international trade flows reduces its access to internationally available technology. Despite some progress in recent years (described in more detail in Chapter V), Guatemala continues to exhibit comparatively low levels of trade volumes as a share of GDP, particularly with respect to regional Central American neighbors and more generally in LAC (Figure 4.1 and 4.2). While trade volumes are usually affected by country size

lZ5See Hall R. and C. Jones (1 999); Dollar and Wolf (1 997); Hall, R., and C. Jones, (1997), “Why Do Some Countries Produce So Much More Output Per Worker Than Others?”, Quarterly Journal of Economics 114(1) 83-1 16; Dollar, D., and E. Wolf (1 997), “Convergence of Industry Labor Productivity Among Advanced Economies, 1963- 1982”, The Economics of Productivity, United Kingdom, Elgar. 116 and transport costs, none of these factors seems to provide a significant reason for the relatively poor performance of Guatemala. Not surprisingly, imports of capital goods as a share of gross fixed capital formation and ofGDP are in the lower range for Central America. In particular, the estimated stock ofpersonal computers (PCs) of 1.4 per 100 inhabitants compares poorly with the Central American average of 5.3. Imports of inputs in general but capital goods in particular are a major source of technology transfer and productivity gains, which may occur either by employing technologically improved inputs into the production process or by learning the know- how embodied in the imported good. A higher share of imports of capital goods may help to increase the quality of the stock of capital and its marginal productivity, thereby increasing its contribution to economic growth.

Figure 4.1: Imports of capital goods, evolution 1997-2001

I 14

-I 1997 1998 1999 io00 200' f 1997 I998 1999 2000 2COl -4- cosra~ic; +E sariador ouaremaia -+-COSQ RI:a +EI saivauor Guatemala HondLrss I NlcoraQus Psnams Hondura; - Nicorsaus f Panama b

E 1997 1990 1999 BOO 2001 e& 1007 1308 I993 2003 2001 -+-Costa Rica +E Savador Guaiemsla +CosIaRim tEISilvador Honduras +Nicarsgua +PanamE 1 Honduras --Nica aqua -PanamaGuarema'a I

Source: ECLAC, World Development Indicators

Figure 4.2: Trade flows lxports + imports) 1

c I993 1991 194 19331991 1996 1436 193719BB 1" a331

tCcstaRca+0%~ Q&T& tinlm -+Nv -+-Pam

Source: World Development Indicators

4.5 Modest levels of Foreign Direct Investment (FDI) also diminish access to international technology. FDI in Guatemala averaged 1.4% of GDP over the period 1997-2001. This average 117 is lower than what would be expected given the country's level ofdevelopment and significantly behind other countries in Central-America (in particular, reforming countries like Costa Rica and Panama), although the difference tends to be reduced due to the generalized drop since 1998 (Figure 4.3).

Figure 4.3: FDI in Guatemala and Selected Countries

I .4 Harduras +Niwagra a- PaMm prrcapila MP PPP paa.11

4.6 Taking into account the size ofthe Guatemalan industry, some progress in the volume ofIS0 (International Organization for Standardization) certifications has been achieved but further improvement is needed. Over the period 1997-2002, 55 certifications have been granted, which is much less than in Costa Rica (260) and Panama (146), but close to El Salvador (60) and more than Nicaragua (21) and Honduras (36) (Table 4.1). There was an increase of IS0 certifications in recent years (2001-2002), reaching 20 certifications in 2002 which ranks Guatemala the 3'd in number of IS0 certifications in Central America. These relatively good figures for Guatemala have to be weighed taking into account the importance of the industrial sector in each country, as IS0 certification is less frequent in service than in manufacturing industries. When the size of the manufacturing sector is taken into account, regardless of the criteria used, the results for quality certification change substantially, with Guatemala ranking in the last position among Central America. Also, preliminary data from the 2004-Guatemala Investment Climate Assessment (ICA) indicates that only 3.3 percent of the surveyed firms had IS0 certification (against 5.4 percent in Honduras and 3.8 percent in Nicaragua) and that only 11.4 percent had any type of quality certification (against 17 percent in Honduras and 2 1.7 percent in Nicaragua). Implementation of effective quality principles and complementary standards and conformity assessment practices are important means oftechnology diffusion.

Source: World Development Indicators 118

4.7 Guatemala has made some progress in terms of information and communication technologies (ICT) but remains generally behind comparators. ICT is a powerful instrument to increase access to knowledge and, as such, a strong catalyst of technology diffbsion. As discussed in Chapter I11 in this CEM, access to telephone service in Guatemala has increased significantly since 1999, following the trend observed also in Costa Rica, Panama or El Salvador. According to statistics of the International Telecommunications Union (ITU), Guatemala had 7.1 main telephone lines per 100 inhabitants in 2002, an increase of 14% between 1995-2002, and 13.2 cellular subscribers per 100 people, an expansion of 76% during the same period (Table 4.2). In spite of the progress made, Guatemala’s performance in terms of access to telecommunication services is low in Central America and when compared to the country’s level of development. Guatemala is also lagging behind regarding the use of information technologies. In 2002, there were 8.2 Internet hosts and 3.3 Internet users per 100 inhabitants, putting Guatemala in 3‘d and 4th place, respectively, in Central-America.

Guatemala Central-America Latin Countries with including I wio America similar GDP per 1 Guatemala I Guate 1 capita *

per 1,000 inhabitants Internet users per 100 inhabitants 3.3 4.4 4.6 8.5 5.1 Internet hosts per 10,000 8.2 9.7 10.0 40.9 4.1 inhabitants

4.8 Low patenting activity illustrates Guatemala’s poor performance in technology generation. Residents’ patent activity in Guatemala is still extremely limited (there were only 13 applications and 2 patents granted in 2000, and 5 application and 3 patents granted in 2001). Although other countries in Central America (with the exception of Costa Rica) experience similar low levels for the number of residents’ patents, Guatemala has the lowest performance when compared to the size of its population or economy (Figures 4.4 and 4.5). Over the last decade, there has been no significant change in the residents’ patents activity in Guatemala, while the number of residents’ patent applications has increased by about 50% in the Latin America and Caribbean region over the period 1992-2000. Although it cannot capture the complexity of technology generation in a country, the number of residents’ patents may be seen as an indicator of innovative performance.

Out of a group of 10 Latin American countries, Guatemala ranks 9 or 10 depending on the criteria used (only Venezuela and Honduras were lower in 2000 for patent applications compared respectively to GDP and to population). 119

Figure 4.4: Evolution of the number of patent applications in Guatemala

tSakdor --E. Guztemalz Handuras NlGragua -+Panama t Sabdor -+-Guamala Honduras Nicaragua +Paama

Figure 4.5: Domestic patents granted to residents and level of development - 2001

log per capita GDP PPP

Source: World Intellectual Property Organization

111. Looking for Possible Causes: Skills and Labor Training; the National System of Quality and the National Innovation System

Skills and Labor Training

4.9 The qualification of the Guatemalan labor force is still low, compared to neighboring countries and countries outside the region with similar development levels. In 2002 the illiteracy rate reached 30% of the population over the age of 15 in Guatemala, compared to 10.5% on average in Latin America (Table 4.3). In 2000, the average number ofyears of formal schooling completed in Guatemala was 3.5 per capita, the lowest average among Central American countries, below countries with much lower per capita income (such as Nicaragua and Honduras) and almost half that of a comparable east-Asian country (Thailand). Performance in terms of secondary and tertiary education is also below all comparable countries. The supply of skilled labor is a necessary condition for better technological performance either because skilled labor is a complement to more efficient technology or because innovation depends on the supply of 120 tertiary qualification. In this sense, the availability of skilled labor may be an important obstacle to productivity gains through better technological performance.

Honduras 23.8 4.8 16.6 58.9 18.8 5.7 Nicaragua 32.9 4.6 28.9 43.1 19.8 8.3 Panama 7.7 8.6 9.1 36.2 35.8 18.8 LAC-Average 10.5 n.a n.a n.a n.a n.a Thailand 4.2 6.8 12.6 61.5 15.1 10.9

Barro, R. and Lee, J. (2002), Education attainment in the adult DoDulation, available at www 1.worldbank.org/education/edstats. 4.10 The relative scarcity of labor may be a binding constraint for productivity gains, as demand for skilled labor seems to be higher than in neighboring countries. According to the 2003 ICA, a typical firm in the manufacturing industries in Guatemala would employ more qualified professionals at all levels. In particular, 1.74 percent of the workforce presented a post graduate degree, as compared to the Central-American average of 1 percent (which includes Guatemala, Nicaragua and Honduras, the countries surveyed in 2003 by the ICA). This overall picture remains correct when mean (instead ofmedian) values are used. Also, Guatemalan firms seem to find it more difficult to obtain skilled technicians or production workers than comparable firms would find - on average - in Central America. A typical Guatemalan firm would take twice as many days than a typical Central American firm to fill a vacancy for production workers and one and one-third as many days to fill a vacancy for technicians (Table 4.4). Results are not substantially changed when the mean value is considered instead. Data seem to indicate that the scarcity of skilled labor is more severe in terms of individuals with basic qualifications (as required by production workers) than specific expertise (as required by technicians). In other words, this may be highlighting that the inelasticity of labor supply in the short-run is higher in the “production worker” segment.

Guatemala Centro-America Average time to fill a vacancy for skilled Mean 39.6 32.8 technician (days) Median 20 15 Average time to fill a vacancy for production Mean I 14.5 17 worker (days) Median I 12.3 16 121

4.1 1 To mitigate the scarcity of skilled labor, a growing number of Guatemalan manufacturing firms have been training their workers and outperforming their peers in neighbor countries. According to a 1998 competitiveness survey, 33 percent in industry provided formal training to their employees, 127 a number that increased to 55 percent according to the 2004 Guatemala ICA. The two figures are not strictly comparable - due to methodological differences in the surveys - but together they provide an indication of recent progress made by the private sector. Indeed, Guatemala’s private sector currently seems to perform better than its Nicaraguan and Honduran counter-parts, whose offer oflabor training programs occur in 38.9 and 49.4 percent ofthe firms, respectively. In Guatemala, the majority of large, medium and small firms provided some formal training, but 62.5 percent ofthe micro enterprises did not provide any. The share of firms providing formal training is higher in the beverage, food and tobacco and chemical industries, while paper and non-metallic goods present the lowest levels. Labour training is a crucial instrument to enhance the capacity of the workforce to adapt to technical progress, especially when the education sector is performing poorly, as seems to be the case in Guatemala.

4.12 Guatemalan firms seem to count excessively on learning by doing and informal training because external training is seen as inadequate. According to the 2004 Guatemala ICA, these are the two most frequent reasons why Guatemalan enterprises do not provide formal training. Counting mainly on informal training and learning by doing may be inadequate when levels of basic education are low, as in the case of Guatemala. Training externalities seem to be an important limitation, especially for large and medium firms, as more than 40 percent of enterprises of those sizes claimed that they did not provide formal training because skilled workers “could readily” be hired from other firms, a typical free-riding strategy. The lack of finds for training seems to be an important constraint for micro and small firms, as for 37.5 percent and 40.6 percent, respectively, training was not affordable “due to the firms’ limited resources.” In the case of external training, 75 percent of the firms say that programs are inadequate for their needs and referred to the poor quality of instructors. From the point of view of the surveyed firms, the top three needed improvements in the market for the provision of external training are the: “updates of the courses regarding work practices/ or machineries currently used by firms”; “more specialized training staff’; and “more options ofproviders.”

4.13 Despite improvements in the reputation of the main governmental provider of this service-INTECAP-labor training policies lack priorities and better incentive-mechanisms. The Technical Institute for Training and Productivity (INTECAP 128) - an autonomous institution with public-private governance - provides most of the in-firm training in the formal sector (Box 4.1). INTECAP has engaged in a modernization process over recent years and is now certified IS0 9,001. In general, private sector users report that the reputation of INTECAP has improved, due to its local presence (34 training centers across the country and 5 mobile units), and the partnerships it has established with other institutions (e.g. Valle de Guatemala’s university). However, INTECAP policies may not be selective enough to ensure optimal performance: in addition to in-firm training, INTECAP provides technical education to young unemployed people (a third of its activity) and is involved in social programs (technical assistance to communities with high levels of extreme poverty, training for prisoners, etc). INTECAP is also in charge of promoting quality certification. Although there was only one IS0 9,000 course in

127 Guatemala Skills, Technology and Productivity Survey (1998), World Bank. 12’ Instituto Tkcnico de Capacitacion y Productividad. 122 the 2003 course catalog (out of 168), INTECAP has increased its involvement in this area: 46 events were organized by the central training center in 2002 to explain the contents and the methodology ofthe norm to enterprises in the construction sector. Other quality-related training was organized for professionals from the sugar cane industry.

4.14 The majority of INTECAP's training services are free of charge while the institution has exclusive access to public funds for training. According to the 2003 ICA, firms consider the availability of services in Guatemala to be comparable to the regional averages and only slightly lower than expected given the country's level of development. However, free access may reduce the incentives for participants to try to get the full benefits of the training. INTECAP operations are paid by a payroll training levy of 1 percent on all enterprises with more than five employees (raising about QlO million per month). This monopoly control over the levy fund gives INTECAP a major advantage over other training institutions, resulting in no significant entry of private providers into the training market. Liberalizing the labor training market in Guatemala is clearly still pending.

The National Quality System 4.15 Quality, standards and norms: the failure of the ICAITI. In 1955, the Instituto Centroamericano de Investigacion y Tecnologia Industrial (ICAITI) was established in Guatemala City as a regional resource. ICAITI was a specialized branch of the Secretariat for the Economic Integration of Central America (SIECA) and had offices and laboratories in the six Central American countries. Significant resources were invested in its metrology laboratory and staff training, but the institute's capabilities were never utilized to any great extent by Guatemala's neighbors, and its limited number of clients was almost exclusively from Guatemala. In 2000, ICAITI was no longer in operation.

4.16 Recent reforms in quality-related issues have created the main institutions needed for an effective National System of Quality and may have a positive impact if appropriately implemented. The Comision Guatemalteca de Normas (COGUANOR) was founded in 1962 to provide standards and inspection services in the areas of health, safety, and consumer protection. Understaffing and inappropriate legal means have led to poorly designed public policies for the quality-related issues.'30 As a result of this situation, the government decided to create the National Quality System (Governmental Agreement 182-2000, art. 1l), headed by the Direccion del Sistema Nacional de Calidad, and to submit to the Congress, a National Law of Q~a1ity.l~' The Direccidn is composed of the Guatemalan Accreditation Organization (OGA), which is a technical unit of the Quality System Direction within the Ministry of Economy'32; the former Guatemalan Normalization Commission (COGUANOR), and the National Center for Metrology, which includes the National Laboratory of Metrology and the Testing and Checking Unit for Legal Metrology. Finally, the Quality Law sets the foundations ofan ambitious quality program.

The liberalization ofthe labor training market has been a major objective of the 2000 competitiveness project initiated by the Guatemalan government with the support ofthe World Bank. I3'Project Appraisal Document - Guatemala Competitiveness project (2000), World Bank. 13' This Quality Bill is a consensus of all interested economic agents. 132 The OGA was created under Govemmental Agreement Number 145-2002 dated on May 31d of 2002. It determines whether the conformity assessment bodies (Testing and Calibration Laboratories, Certification Bodies, and Inspection Bodies (ISO/IEC 17020 Standard)) fulfill the requirements of the national and international standards, and issues norms to standardize goods and processes. 123

Box 4.1 : Labor Training in Guatemala: the INTECAP I INTECAP -- Instituto Tkcnico de Capacitacidn y Productividad -- was created by the Decree No. 17 of May, 19‘h, 1972 as the public institution in charge of labor training in Guatemala. Its mission is to provide technical assistance to enterprises to train their labor force, with the objective of increasing their productivity. Accordingly, INTECAP organizes on-site and distant-training programs and events. INTECAP’s responsibilities include: - Being the technical public institution in charge of developing human resources and increasing productivity, in partnership with the private sector and with other relevant public institutions. - Implementing the training components ofthe Government’s development plans - Acting as a link between the private and the public sector for training-related issues - Promoting and encouraging the increase ofproductivity and the development ofhuman resources in close partnership with other relevant institutions - Cooperating with other institutions promoting Guatemala’s social-economic development, to bring them its expertise in training and productivity enhancement - Providing training-related expertise to the Government and to private entities Legally, INTECAP is a non-profit, autonomous institution with its own capital. Its governing body (Junta Directiva) is chaired by the Minister of Labor and Social Planning, with a vice-chairman (Minister of Economy). It includes six members representing the public sector, six members representing the private sector and three members representing the unions. Although the headquarters are located in Guatemala City, INTECAP is significantly decentralized, through its 34 local training centers and 5 mobile units, and is certified IS0 9,001. In 2002, INTECAP organized 7,777 training events and trained 142,794 people. Participants were firm employees (39%), self-employed (28%) and unemployed (33%). In 2003, training subjects are classified in agriculture (12 courses), industry (1 17 courses), services (25 courses), and general training (14 courses). In 2002, INTECAP also organized technical training for poor communities (2,400 participants in 2002), and for prisoners (700 participants). INTECAP revenues come from a 1 percent training levy, from charging for some services (though most oftraining activities are free) and from foreign assistance. In 2002, INTECAP budget amounted to Q180 million and total assets of 4427 million.

4.17 Availability of resources and capacity building will be the key to the successful implementation of quality-related institutional reforms. The National Quality System has few human and capital resources. The 2003 total budget is ten million quetzals, but the cost of the new building to host the National Laboratory ofMetrology alone is estimated to be seven million quetzals. With regard to human resources, OGA employs four graduate professionals specialized in quality matters; COGUANOR counts with six graduates specialized in standardization while the National Center for Metrology employs four. There are forty evaluators whose role is to consider the accreditation applications that have already been filed. Some other weaknesses can be noted. OGA has been pre-evaluated by IAAC, but does not yet possess its own international accreditation; in addition, some laboratories applying for accreditation reported that excessively bureaucratic procedures concerning fees prevented them from being accredited. 124

The National Innovation System 4.18 Available evidence suggests that the proportion of scientists, engineers and researchers in the Guatemalan labor force is high compared to other Central American countries. Although no updated accounting is available due to insufficient monitoring, the proportion of scientists, over the period of 1996 - 2000, engineers and researchers were estimated at 103 per million people, more than in El Salvador and in Nicaragua, and close to Panama (Figure 4.6). It is, however, far below Costa Rica (533 scientists, engineers and researchers per million people). When considering its development level, data indicates that Guatemala could do better in terms of the supply of scientist and engineers.

Figure 4.6: Level of Scientists and engineers in research and Development - latest available year 1996-2000

3 35 4 laper cams GDP PPP]

Source: UNDP, Human Development Indicators

4.19 In Guatemala there are roughly 108 Science and Technology institutions, but their capacity to engage in output-oriented research and partnerships with private enterprises varies significantly. Among the 108 , there are nine universities (Sun Carlos de Guatemala, Valle de Guatemala, Francisco Marroquin, Mariano Galvez, Rafael Landivar, Rural de Guatemala, del Istmo, Panamericana and Mesoamericana) but four of them have shown a particular interest in the area of technology and innovation (Sun Carlos, Valle de Guatemala, Itsmo and Rafael Landivar). Several isolated initiatives have been launched by these universities to develop cooperation with industry. For example, the Research Center in Engineering from the University ofSun Carlos is creating a find, in partnership with a cement enterprise to finance research work performed by PhD students. This fund would be managed by a joint academic-industry committee. The University del Valle de Guatemala has created a small training center (20 students) in the south west of the country, in close cooperation with the sugar cane industry (see below). The University Rafael Landivar has created a “Science and Technology Unit”, including a consulting center for SMEs (Small and Medium Enterprises). The University de San Carlos has recently organized a ‘tferia de la competitividad”, an event aiming at promoting innovation from SMEs and bridging the gap with the academic sector. These few examples of successful initiatives from universities and technological institutes in Guatemala have something in common: they consist of isolated initiatives, building on some opportunities of building partnerships with the industry, and were not driven by the incentives managed by the national science and technology institutions (CONCYT and FONACYT). 125

4.20 Research and development expenditures are low and volatile. Estimating Guatemala’s R&D expenditures is also difficult as there is no institution monitoring neither public nor private expenditures in this sector. In 1995, public R&D expenditures per worker have been estimated to US$9.6 and private expenditures to US$6.2 .133 At that time, this was an average spending level in Central America (more than Nicaragua or El Salvador but less than Costa Rica). Guatemala’s R&D expenditures in 1995 were, however, far behind the Latin American average (US$34 per worker’for public R&D and US$14 for private in 1995), which was itself lower than other developing countries particularly active in technological progress (that same year, the average for Korea, , Singapore and Thailand reached US$41 for public and US$78 for private R&D expenditures per worker) (Figure 4.7). According to the Ministry of Finance, public expenditures related to Science and Technology amounted to less than Q20 million per year during 1997-2002, i.e. less than USSl per worker (Table 4.5). Although this figure obviously does not account for all public expenditures in Science and Technology (S&T), such a low level of officially registered funding as well as the volatility of the budget line (it exceeded 0.1 percent of total public expenditures only in 1997 and 2001 over the 5 year period), gives an indication of the extent to which S&T policy has been treated as a priority and of its comprehensiveness. 134

Million Q 1997 1998 1999 2000 2001 2002 Total public 11,518 15,517 18,728 19,110 21,327 22,541 expenditures Science & Technology - as % ofpublic 0.1 <0.05 <0.05 <0.05 0 .3 < 0.05 expend. 11.5 < 7.8 < 9.4 < 9.6 64.0 11.3 - amount

4.21 Public R&D expenditures are concentrated in public universities. Major sources of public R&D expenditures in Guatemala include University of San Carlos’ research budget (around QlOO million or US$12 million per year), the “Fondo Nucionul de Ciencia y Tecnologiu” (the FONACYT should receive Q15 million annually but in practice, this amount has been reduced to about a third or less than US$l million per year, 13’ a part of which is used to finance research programs from universities) and other very recent national programs handled by CONCYT (PROINTEC: US$7 million per year and AGROCYT: US$8 million per year). These cumulated public R&D expenditures represented in 2003 less than US$30 million or about US$8 per worker, given Guatemala’s active population. 136 The fact that these public expenditures in

133 See World Bank (2003), “Closing the Gap in Education and Technology,” The World Bank Latin American and Caribbean Studies, Washington, D.C. 134 Regarding private R&D expenditures, the WEF (2003) survey estimates them to be in average for Central and Latin America, and close to what would be expected given the country’s level of development. 135 SENACYT, the institution in charge of FONACYT, reported a significant decrease in available budgetary resources over the past 3 years. ‘36 A large portion ofthese expenditures is also supported by external sources, such as IDB loans for PROINTEC and AGROCYT, or grants from international research programs to assist universities’ research efforts. 126

R&D have had limited impact to reduce Guatemala’s technology gap raises some issues regarding the productivity of these resources.

Figure 4.7: R&D expenditures per worker - 1995 I

0 2,000 4,000 6,000 8000 10,000 12,000 14000 per capXa GDP PPP (19953 per capta GDP PPP (1995j

Source: World Bank

Box 4.2: R&D at the firm level: evidence from Firm Surveys A 1998 survey on Technology and Productivity provided useful information regarding firms’ behavior toward innovation. At that time, a large proportion of firms did not invest at all in product innovation (42% of industrial and 52% of service firms). Also, 66% of Guatemalan industrial firms investing in R&D focused on product (in comparison, in industrialized countries, around 80% of R&D is devoted to improving existing product^)'^'. Finally, in 1998, foreign technology diffusion was low (only 13% of service and 9% ofindustry firms were investing to implement a foreign technology).

4.22 Tightened budgetary constraints reduced public hnds for R&D. In 1992, a national fund for science and technology (FONACYT’38)was created (by the decree 73-92) with the purpose of becoming the main financial instrument to promote research and development in Guatemala. Its objectives stress the importance of using resources as a catalyst to bridge the gap between science and technology institutions and the productive sector.139 But the modest level of budgetary resources allocated to FONACYT was, until recently, clearly incompatible with such a broad mandate. FONACYT should receive an annual funding of Q15 million but in practice, resources have been much less (around 44-6 million per year during the period from 2000- 2003). In addition, only three out of the seven credit lines of FONACYT have been active so far.

13’ McGraw-Hill annual surveys over a number of years, quoted by Rosenberg, N., Uncertainty and Technological Change, 1994. 13* Fondo Nacional de Ciencia y Tecnologia. 139 For instance, its official mandate includes: (1) achieve an adequate transfer of knowledge to the productive sector, through the financing ofjoint projects between universities, research and development centers, and firms or organizations; (2) finance programs or projects to solve technological problems in the productive sector; (3) support training programs in human resources in Science and Technology; (4) finance activities listed in the Science and Technology Development Plan and in the annual work program of the 14 sectoral and Inter-sectoral commissions; and (5) increase the quality and the quantity of scientific research, technological development and service provisions which benefit the development of Guatemala. 127

4.23 Poor incentive-regime also affects performance of public funds. The main credit line, FACYTI4’, had financed 275 projects in 2002, most ofthem with little or no commercial interest. FACYT is mostly used to finance researchers’ salaries and is not conditioned on the performance of. projects. No impact evaluation of the FACYT has been performed. Applicantsfor FONACYT funding complain about the delays between application and the lapse in receiving funding (around 18 months). Some FONACYT managers explain that delays have been caused by the poor quality of research proposals, requiring them to be improved and re-submitted. However, a more likely explanation is that because of the governance structure of the FONACYT: each research application has to be first examined by the CONCYT (a very high level commission which meets four times a year, see below), then by the Consultative Commission for Science and Technology before being re-examined and finally approved by the CONCYT. Long delays, excessive centralism, bureaucratic procedures and low predictability very significantly reduces the way the FONACYT can work as a true incentive to promote research and development programs in Guatemala. Rather, it may be seen by research institutions as a secondary and opportunistic source of funding.

4.24 Two financial instruments have been recently created under the authority of CONCYT. A specific unit within SENACYT is in charge of their management. The first one, PROINTEC, is a US$14 million program (for two years) aiming at promoting technological innovation for small and middle-size enterprises. PROINTEC - which is still in preparation phase - will be aiming at helping technology and innovation providers to design and implement a “technological supply adaptation plan” (PAOT). The program should function as a “matching grant” covering 50percent of service acquisition (e.g. consulting) and 80 percent of goods acquisition (e.g. scientific equipment). The second program, AGROCYT (Competitive Technological Development Fund for Food and Agriculture) is one of the components of a 1JS$42 million program supported by the Inter-American Development Bank to increase the competitiveness of the food and agriculture sector by supporting the reconvention of non-competitive firms, invigorate economic growth, and reduce poverty. AGROCYT provides non-reimbursable resources for agricultural research and has been operational since 2002 with a US$16 million budget for two years. Both programs have been designed with particular attention to the governance structure and the delays of project approval. A technical committee examines proposals, before review by the consultative commission and approval by CONCYT. The objective is to shorten the time between the dates of application and of approval to two months. 14‘

4.25 In addition to direct subsidies, fiscal incentives have been implemented to facilitate technology diffusion but the business community estimates that incentives are less developed than in comparator countries. The Ley de Foment0 y Desarollo 29-89 has established a custom tax exemption program for 10 years, targeting exporting firms that import modern equipment. In 2002, 1,302 firms (mostly large ones) were eligible to these fiscal incentives, 90 percent of which from the textile industry. The program is centrally managed from the Ministry of Economy’s Industrial Policy Division. In spite of the existence of such incentive mechanisms, the business community estimated in 2002 that incentives granted to firms to develop R&D

I4O Fondo de Apoyo a la Ciencia y Tecnologia. 14’ The Inter-AmericanDevelopment Bank (IDB) is supporting both initiatives. 128 programs were lower than the regional average and lower than expected given the country’s level of development (Table 4.6).

Guatemala Central America Latin Countries with including wio America similar GDP per Guatemala Guate capita * Direct govemment subsidies for 2.2 2.3 2.4 2.4 2.8 firms conducting R&D, 1: never occur, 7: are widespreadlarge Government’s tax credit for firms 2.1 2.3 2.3 2.4 2.9 conducting R&D, 1: never occur, 7: are widespreadlarge

4.26 Output-based incentive programs for researchers in Guatemala’s universities are weak. Even though revenues from services constitute a significant part of University of San Carlos’ research institutes’ income, the fact that 20 percent are retained by the University (see below) acts as a negative incentive to develop such services with clients from industry. Moreover, researchers cannot spend more than four out of eight hours daily working for services’ activities. In order to encourage such activities, the University of San Carlos is currently studying the possibility of implementing of an incentive mechanism (“bono de investigacidn por trabajo productive") as a salary premium to researchers working on joint innovation programs with industry.

4.27 Some public research centres provide services to the private sector as a major source of additional funds. The case of the Research Center in Engineering at the San Carlos University illustrates the major sources of funding for a typical applied research center: while salaries are paid by the University’s general budget, the center relies significantly on service contracts for its operating activities. Funding from major public research sources (FONACYT, San Carlos University’s “Direcci6n General de Investigacidn”) is in fact of minor importance (Table 4.7). Moreover, the lack of predictability and the long, bureaucratic process may encourage opportunistic behavior from research centers regarding these funding sources.

Salaries (paid on University’s general budget) about Q2 million (total staff of 58 including 22 research professionals) Research services (80% oftotal services’ income about Q1.2 million go to the Center, the other 20% being retained by (Q800,OOO from contracts with private enterprises and the University) Q400,OOO from contract with municipality of Guatemala to monitor water quality) FONACYT between Q0.2 and Q0.5 million (for research projects) DIG1 (paid on University’s special budget for less than 40.2 million research projects) FUNSIN (association created to raise funding for marginal engineering research projects) (mostly used to buy research equipment) 129

4.28 Market discipline remains limited. Market discipline, fostered by greater competition, can act as a powerful driving force for innovation. According to the 2002 Global Competitiveness Report, the business community estimates that competition in the local market was less developed in Guatemala than in comparator countries (Table 4.8). The 2003 ICA showed that 28 percent of firms considered that they were less advanced then their closest competitor, compared to 2 1 percent average in Central America.

Guatemala Central America Latin America Countries with including w/o similar GDP Guatemala Guate per capita * In most industries, competition 4.2 4.5 4.6 4.6 4.9 in the local market is 1 : limitedprice-cutting is rare; 7: intense and market leadership changes over time

4.29 According to the business community, Guatemala’s Intellectual Property Rights (IPR) legislation does not provide as much protection as in comparator countries due mainly to weak institutional capacity (Table 4.9). Weak institutional capacity remains a major impediment to increasing the treatment of intellectual property applications and to better enforcement of current legislation. The IPR regime is administered and enforced by an institution affiliated with the Ministry of Economy (Registro de la Propiedad Intelectual) which employs a staff of about 70 (including one lawyer and four sectoral experts for patents). The bulk of intellectual property activity in Guatemala comes from the registration of trademarks (3,048 applications from residents and 5,040 from non-residents in 2001). It takes about one year to file a trademark and three to four years for a patent (in the US, the average time to file a patent is 2 years). The cost is US$35 for a trademark and US$l,OOO for a patent. The Registro also performs intellectual property searches for firms wishing to know about the protection status for a specific technology, product or trademark.

Guatemala Central-AmCrica Latin Countries with including wio America similar GDP per Guatemala Guate capita * Intellectual property protection is 2.3 2.9 3.0 3.1 3.2 1: weawnon-existent, 7: equal to 1the world’s most stringent *Countries with per capita GDP PPP between 3,000 and 4,000 USD in 1999. Source: World Economic Forum - World Competitiveness Report 2002 130

4.30 Guatemala’s legal environment covers a reasonably large amount of intellectual property right issues. Intellectual property rights cover industrial property and copyright and related rights. IPRs aim to stimulate innovation and enable consumers to make informed choices between various goods and services. Guatemala’s national legislation includes an Industrial Property law that covers patents, trademarks, industrial designs as well as utility models and geographic indications since 2000.142 A law on Copyright and Related Rights’43was passed in 1998 and amended in 2000 in order to comply with international treaties’ requirements regarding the use of new technologies. Applicability of the industrial property law has been reduced in 2002 - based on the TRIPS agreements - to exclude pharmaceutical products from patenting, but this restriction is about to be lifted after some pharmaceutical corporations complained that their drugs were starting to be copied. Further modification of existing legislation is expected shortly in the fields of copyrights (to protect cable TV signals) and patents. Such changes are in large part fostered by ongoing trade negotiations, in particular within CAFTA. In spite ofthese legal instruments, in 2002, the business community still ranked Guatemala very low in Central America (last before Nicaragua) and far lower than the average observed in Latin America and for countries with similar level of development. In 2003, a climate investment survey showed that 26 percent of firms considered that patenthrademark regulation was a problem for business growth, compared to an 18 percent average in Central America. Finally, Guatemala’s participation in international intellectual property treaties is similar to other Central America countries with some important exceptions such as the Brussels Convention Relating to the Distribution of Program-Carrying Signals Transmitted by Satellite (signed by Costa Rica, Nicaragua and Panama) and the WIPO patent cooperation treaty (signed by Costa Rica and Panama) (Table 4.10).

4.31 National Science and Technology policy is implemented by the National System of Science and Technology (NSST). The main legal instrument for science and technology policies is the Law for the Promotion ofNational Scientific and Technological Development (Decree 63- 9 1) which enumerates the main priorities for Guatemala’s innovation and technology policy. The NSST is headed by a high-level executive body: the National Council for Science and Technology (CONCYT). 144 The CONCYT is assisted by two bodies: the Consultative Commission of Science and Technology provides the CONCYT with technical expertise and assesses the performance of the SINCYT; and The National Secretary of Science and Technology (SENACYT) implements the decisions of the CONCYT. In principle, these institutions are key to promoting coordination within the SINCYT and to foster public-private partnerships around the theme of innovation. In practice, however, their efficiency has been seriously limited by a strong centralism (CONCYT has to approve most decisions), combined with the fact that, in recent years, science and technology policy has not been a priority for the Government. This has caused major rigidities in the system, including long delays to approve

14* Ley de Propriedad Industrial, Decreto No. 57-2000, issued in August 2000 and entered into force in November 2000. ‘43 Ley de Derecho de Autor y Derechos Conexos, Decreto Ley No. 33-98, which entered into force in June 1998, and was amended by Decree No. 56-20000 from November 2000. ‘44 The CONCYT meets four times a year, is headed by the Vice-president of the Republic and includes: the Minister of Economy, the President of the Congress’ Science and Technology Commission, the President of the Industry Chamber, the President of the Agriculture Chamber, the President of the Entrepreneurship Chamber, the Rector of the San Carlos University, a Rector representing private universities, and the President of the Medical, Physical and Natural Sciences Academy. 131 decisions, which were incompatible with the timing required by industrial partners to engage in partnership with research institutions.

Table 4.10: Participation of Guatemala to International Intellectual Property Treaties

WIPO Copyright Treaty February 4,2003 CR(02), SV(02), HN(02), NC(03), PN(02) WIPO Performances and Phonograms Treaty January 8,2003 CR(02), SV((02), HN(02), NC(03), PN(02) Budapest Treaty on the International Recognition of the Deposit NO None of Microorganisms for the Purposes of Patent Procedure Hague Agreement Conceming the International Deposit of NO None Industrial Designs Lisbon Agreement for the Protection of Appellations of Origin NO SV(97) and their International Registration Madrid Agreement Concerning the International Registration of NO None Marks Patent Cooperation Treaty NO CR(99), NC(03)

4.32 Attempts to institutionalize innovation networks in Guatemala include the fourteen sector and thematic commissions affiliated with CONCYT, but their impact has been limited thus far. Interface instruments capable of bridging the gap between academic R&D institutions and the productive sector are almost non-existent in Guatemala, particularly with regard to small and middle-size enterprises (SMEs). This does not mean that there are no successful examples of innovation partnerships in Guatemala (see below the example of the sugar cane sector, Box 4.3) but these few isolated cases have been developed without public support. As illustrated by a 2003 CEPAL survey in selected LAC countries, in Guatemala there are almost none of the most common technology and information-based policy instruments to support SME development (Table 4.11). Some of the few existing technology extension services are provided by INTECAP. For the most part, these are specific technology transfer initiatives supported by foreign agencies. In 2002, for example, INTECAP organized training sessions in the area of 132

computer science with the support of Korea, in the area of new generation diesel engines with the support of , in the area of food processing with the support of Japan and in the area of wooden furniture industry with the support of Chile and Finland.

Table 4.1 1: SME Development Mechanisms for Technology and Information in - Selected LAC countries Argent Chile Colombia I Costa 1 El 1 Guatem Mexico Panama Venez - Financial support X -X X X 101 0 X Fiscal incentive NA -X X 0 1x1 0 X & Technology advice 0 -0 X 0 1x1 0 X Incubators X 0 X Technology parks X 0 X One stop shop 0 -0 NA NA X NA Other S&T X X NA NA X X NA instruments - RestructJmanagmt X 0 NA NA X NA X programmes X 0 X 0 0 0 X - entrepreneurship X 0 X 0 X x X - competitiveness X 0 X X 0 0 X - quality management X 0 X 0 0 0 X X NA - others - Technical assistance X X NA 0 X 0 X fund Source: CEPAL, 2003

4.33 Quality of public research institutions. According to the 2002 World Competitiveness Report, the way Guatemalan firms perceive the quality of research institutions is consistent with the Central America average, slightly lower than the Latin America average and significantly lower than what would be expected given the country’s level of development (Table 4.12). However, universities and public research institutions have little impact on firms’ innovation strategy: the 2003 ICA has shown that only 0.4 percent of firms report that universities and public institutions have been leading the way to acquire technological innovations (Table 4.8).

Guatem Central-AmCrica Latin Countries with ala including I w/o America similar GDP per I Guatemala I Guate 1 capita *

as universities and public research laboratories are 1: non-existent, 7: the best in their field *Countries with per capita GDP PPP between 3,000 and 4,000 USD in 1999. Source: World Economic Forum - World Competitiveness Report 2002 133

Figure 4.8: Leading the way for Guatemalan firms to acquire technological innovation, 2003 _- -

from .nivefs.Les pub c llSLlUtO-6 I

ansUltantS

I traae fairs and ci stdy twrs I froma ~usmci inaustry I -anon I dedopea wth WL pm?nt ci mactmysqpers $1 devaopeo n moperanon wfh nterlt fims

uansfemed from parent mmpany I I debeopeaaaapla mtnn &ad =men( 0cd1y I Iicenongtm~eymanor6 I from dmucshlrces I cenorgitmkey opetanor6 frcm intemaucm sarces

n nng key personre4

Embwied n w maminery ~~~pment

IGuatemala ICentrc-America I

Source: World Bank - Guatemala ICA 2003

4.34 Clusters are still a limited phenomena in Guatemala, inhibiting inter-firm cooperation. Geographic concentration of interconnected firms in a specific area (clusters) is essentially the outcome of economies of agglomeration and technological externalities (spillovers). According to the 2002 World Competitiveness Report, cluster development in Guatemala is slightly more advanced than in the rest of Central America, but remains around average for Latin America and lower than expected given the country’s level of development (Table 4.13).

Guatemala Central-AmCrica Latin Countries with including w/o America similar GDP Guatemala Guate per capita * How common are clusters? 2.9 2.8 2.7 2.9 3.0 (1: limited/shallow;7: commoddeep) 134

4.35 The sugar cane and the textile industries are relatively well clustered. Most of the sugar cane enterprises are located in the south west of the country and have developed tight cooperation, including the area of innovation with the development of a specific research center and the creation of a training center in partnership with the university Valle de Guatemala(Box 4.3). The textile industry is also developing rapidly, with a phenomenon of “vertical integration” (integration of local suppliers), but no “cluster-type’’ initiatives have been reported to date in the area oftechnology and innovation. 135

Box 4.3: A successful example of cluster in Guatemala: the case of the sugar cane industry

The Guatemalan sugar-agro industry has 17 sugar mills (ingenios), with a combined milling capacity of 125,190 tons of cane per day. The planted area comprises 185,000 hectares where 1.7 millions of tons of sugar are produced annually, of which 72 percent is exported, representing 3 percent of GIP (US600 millions). Sugar ranks as the second highest currency revenue of the country. Additionally, the sugar industry generates 24 percent ofthe private-generated power of the industry. Regarding the international ranking, Guatemala is the sixth largest sugar exporter world-wide, after Brazil, the European Union, Australia, Thailand and Cuba. In 1992, the Guatemalan Sugar Cane Research and Training Center (CENGICARA) was founded by the Guatemalan Sugar Association (ASAZGUA). The seventeen sugar mills participate in the center, each one contributing according to its contribution to national sugar production. The main objective of CENGICANA is the improvement of productivity of the sugar cane crop and its by- products through the generation, adaptation and transfer of quality technology for the profitable and sustainable development ofthe sugar industry. CENGICARA is an important pioneer project of applied research that is completely funded by the private sector. It is managed by a board of directors where the ingenios are represented, and the rest ofmembers are technicians and researchers. Also, there is a Advisory Technical Committee formed by one delegate from Guatemalan Society of Sugar Cane Technologists (ATAGUA), two delegates from CASSA, one person representing the sugar cane producers and one delegate of each ingenio. This committee, together with the technical staff of CENGICARA, designs and makes the Strategic Five-year Plan, that has to be approved by the board. The results of this pioneering project, as measured by productivity increases since 1991192, have been remarkable as the graph below shows.

Source: Cengicaiia CENGICARA develops four main programs coordinated by technical staff: The sugar cane variety development program, the integrated pest management control program, the agronomy program, and the technology transfer and training program. Regarding the varieties program, CENGICANA has received the authorization by the International Society of Sugar Cane Technologists (ISSCT) to use the initials CG to identify the varieties that it has developed. Also, two new varieties obtained by CENGICARA are in the process of being patented in Guatemala. Within the training and technology transfer program, and with the support of INTECAP, 194 activities were undertaken during the last year, including courses, seminars, and diploma-earning seminars. The University Del Valle, with CENGICARA's support, graduated 14 professionals from the Master's degree on sugar and engineering technology in 200212003, and 13 in 2001/2002. 136

IV. Policy Options

4.36 Based on the assessment of Guatemala’s standing in terms of its NIS, this section will discuss some possible recommendations for the technology and innovation policy reform.

4.37 Where the country stands: Guatemala’s technology and innovation gap holds back the overall competitiveness performance of local firms. This report shows that Guatemala performs poorly in terms of technology when benchmarked with similar countries outside the region. It also shows that the country’s technology and innovation performance is close to Central American neighbors, such as El Salvador, Honduras and Nicaragua, the last two of them with lower development levels. More significant, however, is the fact that Guatemala technology indicators come out less well than its overall competitiveness. As shown in Table 4.14, Guatemala is ranked fourth, among Central American countries, in overall competitiveness index, but sixth in the field of technology. In fact, the country is ranked lowest in technology absorption and technology transfer sub-indexes.

competitiveness

Source: World Economic Forum - Global Competitiveness Report 2003

4.38 Despite poor performance, Guatemala seems to be better positioned than neighboring countries in terms of the supply of key inputs and institutions. In labor training, WTECAP has started a modernization process, which includes establishing partnerships with other institutions and expanding its geographic coverage. In the area of quality, recent measures created or improved main institutions needed in modern national quality systems, including a new quality law and the newly created OGA. In the field of technology, selective tax-breaks and subsidies, such as those provided by FONACYT; an internationally consistent IPR and a relatively large number of universities- such as the University of Sun Carlos and University ofRafael Landivar -- and of research institutes are available. Also, CONCYT supposedly provides the coordination for the Guatemalan NSST, with SENACYT functioning as an implementing body.

4.39 Better technology and innovation performance in Guatemala may be achieved with better policy design, particularly in setting the priority areas. Policy design must take into account the availability ofresources, including factor endowments; the market failures it seeks to correct; the sequencing of proposed reforms and the incentives generated for efficient decision-making. Technology and innovation are capital (human and financial) intensive goods and the relative supply ofkey inputs (supply of engineers and scientists, R&D expenditures, etc) may be difficult to affect in the short term. Therefore, “the quantity-effect’’ of policy-change may be limited, especially as countries face severe budgetary limitations. As the likelihood of success of policy 137 interventions increases with the importance ofthe market failure they seek to correct, focus is an essential property oftechnology policies. Externalities oftechnology generation, absorption, and diffusion are generally the appointed problem. Lack of information - on the properties of inputs and how to use them - as well as access to financial market are complementary problems. Attention should be paid to interactions between skills and technology absorption, rule of law (enforcement of IPRs) and innovation, among others; to careful packaging and to sequencing of areas. Finally, it is essential to keep in mind the need to avoid falling into the trap of government-failures substituting for the market failures one needs to correct. In this sense, defining incentive-compatible programs to enforce envisaged policies towards not only the private sector but also the public research institutions - and the linkages between them and the private sector - may be also recommended.

4.40 Taking into account the strengths and weaknesses of the Guatemalan NIS, the overall investment climate constraints, fiscal limitations and the some interdependencies among policy variables, we suggest that Guatemala consider the following five main objectives:

(i)Increase the supply of skilled workers through labor training: According to most indicators, the supply of skilled workers in Guatemala is smaller than that of neighbor countries or countries outside the region but with similar level of development. A relatively low performance of the overall educational system and of INTECAP suggests that a large reform effort is needed. Because the supply of skilled labor directly and indirectly affects productivity growth, efforts in this area might generate substantial net returns.

(ii)Facilitate technological upgrade of manufacturing firms: The quality of capital in Guatemala has decreased since the beginning of the 1980s and the country performs poorly in terms oftechnology absorption and diffusion.

(iii)Facilitate product upgrade through quality certification: Guatemala’s quality certification is lower than neighboring countries, but major necessary infrastructure for quality certification seems to be in place. Quality certification is a central ingredient to allow exporting firms to fully benefit from CAFTA. Considering recent institutional progress, this seems an area where possibly small additional government effort might generate large return.

(iv) Provide the right incentives for profit-oriented R&D activities: The low Guatemalan human capital base impedes an overall specialization in capital intensive activities such as R&D. In this sense, Guatemala’s private sector should focus R&D activities on product niches that provide higher returns.

(v) Improve governance of technology policy: Budget allocation over the years, program design and evaluation, as well as capacity and institution building have not been consistent with the formal priority given to the S&T sector. As a result, the capacity to formulate, implement, and evaluate coherent technology policies has not improved. Yet, due to important market failures, coherent, incentive-compatible and cost-effective technology policy is a necessary ingredient of a well-functioning NIS regardless ofthe country’s stage of development. 138

4.41 In order to achieve the five aforementioned objectives, the following instruments/ intermediate steps, among others, might be useful:

(a) Reduce attributions of INTECAP to focus on labor training (possibly transferring attributions related to social policies). Introduce competition for the provision oflabor training, incentives for training to respond to firm demand and partial cost-recovery to ensure that participants try to obtain the full benefits of training. Invest in the qualification of INTECAP’s training staff and in matching course programs with needs from the private sector.

(b) Measures to facilitate technology absorption and diffusion:

(i) Review trade policy in order to improve trade integration and thereby technology absorption through acquisition ofbetter intermediate goods.

(ii) Facilitate import of capital goods by reviewing import tariffs, existing tax benefits and improving access to financing acquisition of machinery and equipments, especially for micro, small and medium firms, as well as the scope of measures (possibly extending the measures to the acquisition of computers and related goods).

(iii) Adjust FDI policy to gradually attract more technology-intensive investments. In order to increase the impact of FDI on technology transfer, Guatemala does not necessarily need to achieve a Costa-RicadIntel type of result. The most feasible would probably be to focus on sectors that have been aggressively adopting ICT technology, one of the main sources of productivity gains over the 90’s. Among others, these sectors would include the banking and retail sectors, the last one also subject to important scale economies. 145

(iv) Technology extension services. Because information is costly to achieve and involves externalities, while enterprises - specially micro, small and medium - are frequently credit rationed, the lack of information might be an important obstacle to technology acquisition and diffusion. In this sense, technology extension services - similar to those employed in agriculture sector - might be a useful tool. Technology services may offer different emphasis in terms of the type and the purpose of the service provided, as illustrated by Table 4.15.

14’ Van Ark, Inklaar, McGuckin (2002), demonstrate that most of the productivity growth of the US economy during 1995-2000 may be attributed to the service industries mainly - although not only -- derived from the use of ICT technologies. The authors also argue that all of the productivity growth differential between the US and Europe in this period was generated in three sectors - retail, wholesale and security trading. Yet, technology gains in these sectors were generated not only by ICT use but also by economies of scale associated to newly build “big box” stores. See Van Ark, B., R. Inklaar, and R. H. Mc Guckin, 2002, “ Changing Gear: Productivip, ICT and Service industries: Europe and the United States, ” paper presented to Brookings Workshop on Services Industry Productivity, Washington, D.C., May 17. 139

Table 4.15: Technology Extension Services in Selected Countries Type of Service Purpose Example

1. Technical To assist firms in diagnosing U.S. - Manufacturing Assistance technology needs and in problem- Extension Partnership under (extension solving the NIST services)

2. Broader To increase the use of S&T - Innovation and Assistance resources including: TA, MSTQ, Technology Centers (non- training, and information profit institutions)

3. Information To enrich the technology related Canada - Canadian information resources available to Technology Network firms

4. Technology To match firms with supply of - Danish Brokers ready-to-use technologies Technological Institute Brokerage Service

(c) On quality: guarantee the conclusion of quality-related institutional reforms and the availability ofresources for the well fimctioning ofthe National System of Quality.

(d) Incentives for profit-oriented R&D:

(i) Promote output-basedmarket-oriented R&D in public research institutes and universities, by possibly:

- gradually reducing their access to earmarked funds (if necessary) and - at the same time-expanding their autonomy to look for new sources of funding, particularly through different partnerships with the private sector; and

- introducing flexibility in the regulation ruling the assignment of property rights over inventions generated in these institutions, possibly allowing main researchers and their institutions to benefit from their discoveries;

(ii) Improve economic incentives for technology transfer from public research institutes and universities to the private sector;

(iii) Enhance institutional capacity to enforce IPR laws, possibly by up-grading the Registro de Propiedad Intelectual, investing in process simplification and staff training.

(iv) Increase gradually public expenditures on R&D for activities with commercial return, as well as its stability. 140

(e) Measures to improve governance would include:

Defining a coherent federal technology and innovation policy, establishing a set of programs designed to achieve measurable objectives, as well as its main funds;

Strengthening policy-making, coordination and evaluation capacities, possibly at SENACYT;

Simplifying concession of public funds to avoid unnecessary delays, possibly granting more autonomy for FONACYT managers on the evaluation of research proposals; and

Improving transparency and accountability of technology and innovation policy by improving national statistics on R&D;

(0 Overall suggestions for policy definition:

(i) The use of matching grants -as is supposed to be developed by PROINTEC- tend to be more cost-effective than simple grants, tax-breaks or direct subsidies; and

(ii) Sector and size focus might help in developing some programs - such as those offering technology extension or quality enhancing services. Bundling services, such as quality and technology extensions, might bring scale and economies of scope in provision. Chapter V. Trade and Growth in Guatemala

I.Introduction

5.1 This chapter reviews Guatemala's key government policies in the trade realm, in an attempt to understand if there are further refinements that could help unlock the potential oftrade in contributing to growth. It also examines the challenges and possibilities offered by the upcoming free trade agreement between the Central American economies and the United States (CAFTA) and makes recommendations on how to best use this opportunity to expand trade flows and growth in Guatemala.

5.2 Trade expansion plays a critical role in stimulating economic growth, which is a key ingredient to poverty reduction. Undistorted price signals from world markets allow resource allocation consistent with comparative advantage, thereby increasing productivity. An open trade and investment regime encourages integration into the global trading environment and the import of diverse and modern technologies that are important for productivity improvements. Most cross-country studies'46 also seem to confirm this theoretical view and have found a positive relationship between trade openness and income growth. '47

5.3 Although the relationship differs substantially from country to country, growth in incomes of the poor is strongly related to overall growth in the economy. The link between overall growth and poverty alleviation has been demonstrated both in cross-country analyses (Dollar and Kraay, 2000), and for many individual countries. Trade liberalization can therefore be expected to help the poor overall, given the positive association between openness and growth. This is particularly important in the case of a small economy like Guatemala, in which domestic markets are limited. By widening the extent of the market, foreign trade further enhances the growth prospects of a small country by allowing it to overcome the limitations in specialization and productivity growth imposed by a reduced domestic market.

5.4 Guatemala has made some progress in terms of trade openness in the 1990s. Trade flows (exports plus imports as percentage of GDP) increased by 11 percentage points between 1991 (39 percent) and 2001 (50 percent) (see Figure 1). However, most of this progress can only be attributed to import growth as total exports have remained practically stagnant for the last ten years at around 19 percent of GDP, despite positive developments in exports of maquila and other nontraditional products.

146 See Dollar (1992), Sachs and Warner (1995), Edwards (1998), Frankel and Romer (1999), Dollar and Kraay (2000), Alesina, Spolaroe and Wacziarg (2000) and Dollar and Collier (2001). 14' Even though this view has been challenged on the grounds that some measures of openness capture the effect of other economic variables (for example, Exchange Rate Black Market Premium in Rodriguez and Rodrik (1999), a recent study by Lederman and Maloney (2003) suggests that the concentration of export revenue hampers growth, whereas trade liberalization policies have a positive effect on growth. 142

5.5 Guatemala’s progress in increasing trade flows is poor in comparison to other LAC countries of comparable economic size and conditions (Table 1). Most significantly, Guatemala still exhibits the lowest share oftrade in GDP in Central America and is well below the region’s 2001 average of 75 percent.’48 Guatemala’s trade share is also below other comparable economies like the Dominican Republic, Panama and Ecuador. The lack of dynamism of Guatemala’s exports is reflected in World Trade Organization (WTO) figures, according to which its share of world merchandise exports decreased from 0.07 percent in 1980 to 0.04 percent in 2001, a drop by almost half in two decades.

Figure 5.1: Guatemala Trade as YOof GDP

40% ‘ I 1 30%- -I

-...... -.. .. -.. .. _..-- -0.. ._...... - ..-.- -- -.- - -.... ‘ 10% .. . . - . .. Exports -Imports -Total

1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

kurce: Central Bank of Guatemala, using National Accounts data.

5.6 Poor trade performance is one of the main factors behind the low rates of GDP growth observed during the last decade in Guatemala. Between 1991 and 2002, GDP growth averaged 3.8 percent and per capita growth was merely 1.1 percent. As indicated in Chapter 1, increasing trade openness from its current level to the 75TH percentile for Latin America could potentially increase the trend growth rate ofGDP per capita by 0.4 percent during the next decade.

5.7 The stagnant export ratio of recent years is the result of significant differences in the dynamics of three different sectors. The first is the maquila sector, which has shown impressive growth since 1990, with net exports increasing steadily as a result of US trade preferences and the success ofthe free trade zone regimes in attracting FDI.’49To give a sense ofthe impressive growth of this sector, its exports grew at an average annual rate of 18 percent in U.S. dollars between 1992 and 2002. The second is the group of traditional export products (Le., coffee, bananas, sugar and cardamom) which have seen trade volumes fall steadily during the 1990s, as

14* This conclusions do not change even if account is taken of factors that may be exogenously related to trade such as population size and area and whether the country is an oil exporter or is landlocked. 149 The Guatemala maquila sector is distinguishedin Central America for its emphasis on delivering the so-called “full package”, in which textile producers are responsible for most phases of production. This ability fosters a competitive edge based on service delivery rather than solely on low labor costs. 143 a consequence of slow demand growth and low commodity prices. The third is nontraditional exports (e.g., flowers, seasonal vegetables, fruits, and organic crops), which grew dynamically until 2000 but have stagnated since, due to lower growth in the international economy. Nevertheless, rapid growth in the 1990s of non traditional exports have made Guatemala into one ofthe most diversified exporters in Central America. 150

Table 5.1: Trade flows as percentage of GDP"

1991 2001 Guatemala 38.91% 50.03% ExportsiGDP 18.26% 19.39% ImportsiGDP 20.65% 30.64% El Salvador 42.10% 57.10% ExportsiGDP 13.60% 20.70% ImportsiGDP 28.50% 36.40% Honduras 69.10% 127.60% ExportsiGDP 34.20% 58.30% ImportsiGDP 34.90% 69.30% Nicaragua 32.1 0% 71.30% ExportsiGDP 9.30% 24.40% ImportsiGDP 22.80% 46.90% Costa Rica 58.70% 70.30% ExportsiGDP 26.50% 30.10% ImportsiGDP 32.20% 40.20% CA average 48.2% 75.3% ExportslGDP 20.4% 30.6% ImportslGDP 27.8% 44.7% MCxico 35.6% 66.5% ExportsiGDP 16.4% 32.5% ImportsiGDP 19.2% 34.0% Dominican Republic 54.0% 86.1% ExportsiGDP 24.6% 39.2% ImportsiGDP 29.4% 46.9% Brazil 14.8% 23.1% ExportsEDP 8.4% 11.0% ImportsiGDP 6.4% 12.1% * Exports and imports of goods, including gross maquila flows. Source: World Bank with data from Central Banks and private sector sources.

150 Growth of non traditional agricultural exports has been attributed to (i)agricultural policies to promote diversification; (ii)access to long-term financing from public credit programs that allowed small and medium farmers participate in this process and (iii)investments in infiastructure (irrigation, roads and electricity). In addition, private organizations and trade associations like the Non Traditional Products Exporters' Association (AGEXPRONT), played a catalytic role in promoting nontraditional exports (Monge and Gonzalez Vega, 2003). 144

5.8 The stagnation of export flows since 1990 and the sub-par economic growth record ofthe past few years suggests that the potential for trade in the Guatemalan economy has yet to be fully exploited. Even the dynamic maquila sector, which relies greatly on imported inputs, has not developed strong linkages with the rest of the economy. A key challenge for the future is to boost and diversify trade in order to improve economic growth and poverty alleviation.

11. Review of Trade Policies

5.9 Since 1986 Guatemala has taken steps to promote trade expansion and economic liberalization. Substantial progress was made in reducing tariff rates, eliminating most non-tariff barriers (NTBs), removing export licenses and taxes,15' and removing domestic price and foreign exchange controls. These policies have been complemented with a more open foreign investment regime and flexible foreign exchange arrangements.

Import Tariffs

5.10 With an average of 7.2 percent in 2002, Guatemala has one of the lowest tariff rates in the LAC region (see Table 2). Although the tariff reduction process started unilaterally back in 1986 when the average tariff rate was reduced to 21 percent, it was further consolidated by a joint effort of CA countries to establish the Central American Tariffs System (SAC in Spanish). Since December 1999, Guatemala's tariff schedule is based on the SAC, which has a maximum tariff of 15 percent. 15* However, out of quota tariffs for certain agricultural products traditionally destined for domestic consumption are higher than the 8.5 percent average tariff ofthe rest ofthe agricultural sector (see next section on Nontariffs Barriers).

- Table 5.2:Averamates in CACM countries (in YO) - Costa Rica El Salvador Honduras Guatemala Nicaragua Tariff Range 0-163 0-40 0-55 0-40 0-170 By ISIC sector Agriculture and fisheries 9.8 8.6 8.1 8.5 8.7 Mining 4.6 2.2 2.3 2.4 2.3 Manufacturing 6.8 7.5 6.0 6.9 5.8 Total 7.0 7.4 6.1 7.2 5.9

Source: various WTO Trade Policy Reviews.

Non Tariffs Barriers

5.1 1 The use of non-tariff barriers appears to be limited in Guatemala. No recourse of anti- dumping, countervailing or safeguard measures has been made in recent years.153 Import

~~ Guatemala maintains export taxes only for the coffee sector. Coffee growers must pay 1% ofthe f.0.b. price. 15* The SAC has established the following four-tiered tariff structure: 0 percent for raw materials, intermediate and capital goods not produced in the region; 5 percent for raw materials produced in the region; 10 percent for intermediate and capital goods produced in the region; and 15 percent for finished goods. 153 An exception has been a case against Mexico regarding cement, which was found by a WTO panel to be inconsistent with multilateral rules and was removed by Guatemala before the panel's final verdict. 145 prohibitions are in place for the protection of human health, animal and plant life, the environment, or essential security interests and military reasons, in compliance with domestic legislation and WTO commitments. Nevertheless, under its minimum-access commitments, Guatemala maintains since 1996 import quotas for rice, yellow corn, wheat flour, apples and sugar.'54 The in-quota tariffs for these products range from 0 to 12 percent for apples, while out of quota tariffs tend to be higher: rice (29 percent), yellow corn (35 percent), apples (25 percent), sugar (20 percent) and wheat flour (10 percent). Tariff quotas on poultry and bovine meat were eliminated in 2001 and 2002, respectively. Poultry had the highest out of quota tariffs at 45 percent.

Free Trade Zones

5.12 Guatemala has adopted special legislation for enterprises located in free-trade zones (FTZs) and maquila enterprises, offering a mix of special tax exceptions and other fiscal incentives to those enterprises. The Export Promotion and Maquila Law (29-89) applies only to exports outside the Central America Common Market (CACM), irrespective of the place of production, whereas the Free Trade Zones Law (65-89) refers to all exports for which production takes place in special, geographically determined areas.

5.13 The FTZ Law offers exemption from import duties, value-added tax (VAT) on imports and sales between FTZs, and exemption from income tax over a period of five years for commercial companies and ten years for industrial and service companies. Approximately, 14,000 jobs have been created in 15 zones that operate under this regime. Under the Maquila Law, imports by maquila enterprises are exempt from duties and other taxes, including VAT. Additionally, maquila enterprises are exempt from income tax over a period often years. In total, the Maquila Law covers approximately 866 enterprises with more than 83,000 employees. The main export market under both regimes is the United States and, in the case of the Free Trade Zones, the other Central American countries. The main activities are commerce and the production of textiles and apparel (around 80 percent of total), pharmaceuticals, carton and plastic products, fertilizers, pesticides, and aircraft parts.

5.14 With more than 80 percent ofthe enterprises operating under the Maquila and FTZs Laws in the textile and apparel industry, Guatemala needs to make substantial increases in productivity and efficiency in the sector in order to maintain its ability to promote exports and employment in the future, as an eventual end to FTZ arrangements has been agreed at the WTO by 2007. In the future, Guatemala will need to rely more on offering a sound investment climate to investors rather than specific tax incentives like in the FTZs regimes.

International Free Trade Agreements and Preferential Regimes

5.15 Since the early 1990s, Guatemala has been an active player on regional and bilateral Free Trade Agreements (FTAs). It joined GATT in 1991 and became a full member of WTO in 1995; reenergized the Central America Common Market (CACM) with the other Central

Guatemala has recently increase the sugar quota that can be imported at zero tariffs, from 5,000 to 100,000 metric tones, drastically reducing the protection to the sector. The out ofquota tariff remains at 20 percent. Exports (fob] by trade Partner Imports (cift by Tfada Partner 147

5.18 The CBERA grants unilateral duty-free treatment on exports to the U.S. of certain eligible articles that follow strict rules of origin (i.e. contain a minimum 35 percent local content of one or more beneficiary countries). Then, under the CBTPA, unlimited duty- and quota-free treatment is provided for apparel assembled in the CBI from U.S. fabrics formed from U.S. yarns and cut in the United States (NAFTA parity). In contrast to the CBERA, which is permanent in duration and redefined from time to time, the CBTPA benefits are legislated to expire on September 30, 2008, or upon entry into force of the Free Trade Area of the Americas (FTAA), whichever comes first.

Figure 5.3: Textile Imports to the U.S.

2,500,000 2,250,000 2,000,000 1,750,000 1,500,000 1,250,000 1,000,000 750,000 500,000 250,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Period

.~ ... .

5.19 Guatemala has greatly benefited from CBI trade preferences, explaining much of the increase in exports during the 1990s (see Figure 3). According to figures from the U.S. government, Guatemala ranks fourth among CBI import suppliers of apparel and textiles, behind the Dominican Republic, Honduras, and El Salvador. Also, Guatemala has taken great advantage of the preferential treatment for agricultural imports granted by the CBI, surpassed only by Costa Rica in Central America. According to Monge (2003), Guatemalan nontraditional agricultural exports to the U.S. market increased from US$454 to US$731 million between 1989 and 2001.

Exchange Rate Policy

5.20 Maintaining a stable macroeconomic environment is crucial to promote growth and support poverty reduction. A competitive exchange rate policy is one important element of such a strategy that also supports export expansion and trade-related growth. Figure 4 shows that the real exchange rate in Guatemala appreciated 6.5 percent on average between 1990 and 1997. 148

However, since 1998 the quetzal has remained practically stable in real terms, with an average annual rate of appreciation of merely 0.1 percent.’57

5.2 1 Guatemala maintains a nominally flexible exchange rate system, although the Central Bank intervenes in local capital markets with sterilization operations that prevent strong swings in exchange rate fluctuations. As explained in Chapter I,since much ofthe real appreciation that is evident since 1990 can be attributed to large capital and remittances inflows, there is not much leeway for monetary policy interventions that can alter this outcome of fundamental market forces. Ultimately, continued productivity increases will be the key to improve the competitive position ofthe external sector, as pointed out in Chapter IV.

Figure 5.4: Guatemala Real Exchange Rate Index 1990 = 100

i 170 I/ I I I

I/ I I

I/ I I

T 90 91 92 93 94 95 96 97 98 99 00 01 02 03

i Source: International Monetary Fund. Average~ for the year, data_~______for 2003 is as of August. j L ~

Summary and Evaluation

5.22 Progress on trade policy reform has been significant in Guatemala since the early 1990s. Tariff levels are now low and export promotion mechanisms are broadly consistent with international norms. On the import side, a few tariff peaks remain (in agriculture) but the use of non-tariff barriers is not significant, aside from the quotas associated with sensitive agricultural products. Preferential access to the U.S market have led to significant growth in maquila and non-traditional agricultural goods. The former has also benefited from incentives to investment granted by FTZ regimes.

5.23 However, despite the implementation of a positive trade policy framework over the last decade and a half, the growth oftrade flows has been disappointing, in particular that of exports. Clearly, bottlenecks to further trade exist outside the narrow sphere of trade policy. In the next section, we focus on other fronts of action that should be addressed to take better advantage of growth opportunities from trade.

Is’Furthermore, a real depreciation of 3 percent has taken place between January and August 2003. 149

111. CAFTA Implications For Guatemala

5.24 Guatemala and the U.S. ended negotiations for CAFTA a the end of 2003. The treaty should enter into force after ratification by congresses, expected for late 2004 or early 2005. CAFTA will be the third agreement ofthis type between the U.S. and Latin American countries, following those signed with Mexico (1994) and Chile (2003). For the U.S., CAFTA is seen as a complement to the hemisphere-wide FTAA initiative, by facilitating the participation on a FTA of those countries that have made progress towards free trade within the LAC region. Implementation of the agreement is expected for early 2005. While Guatemala is already a very open economy, CAFTA offers new opportunities as well as challenges that could have a profound impact on its development prospects.

5.25 Although Central American countries already enjoy preferential access to the US market through the CBI, CAFTA will widen the opportunities to boost exports, investment, growth and employment by granting expanded and more stable access to the biggest market economy in the world. In particular CAFTA will provide a broad framework for trade and investment relations between the US and the CA countries that will be substantially more comprehensive and far reaching than the current unilateral preferences under the CBI.

5.26 First, CAFTA will be a reciprocal trade agreement, granting broader rights and obligations in terms of market access and dispute resolution to both sides. Secondly, it will provide a permanent framework for trade and investment relations as opposed to CBI preferences, which required occasional renewal to sustain the regime in time. Third, in addition to trade in goods CAFTA will include regulations for trade in services and rules and disciplines for investment relations between member countries. Finally, it is likely to comprise regulations on areas such as e-commerce as well as specific norms on sensitive issues such as intellectual property rights, government procurement, labor and environmental standards.

5.27 The more comprehensive nature of CAFTA is expected to ‘lock in’ trade liberalization and other structural reforms undertaken in Guatemala during the last decade, providing a credibility effect that that will enhance investment and growth prospects. However, as the experience of Mexico shows, CAFTA alone is not enough to generate a large growth response (World Bank, 2003). Guatemala needs to advance in a broad agenda of reforms, investments and institutional modernization that are critical to take better advantage of growth opportunities from trade and particularly from the new trade agreement with the U.S.

5.28 In what follows, a review of key changes in norms and regulations required in order to implement the agreement and, more importantly, to enforce its regulations is outlined. Then we outline key complementary actions and reforms that Guatemala needs to undertake in order to maximize the potential growth gains from CAFTA in the medium and long term.

The content of CAFTA

5.29 This section presents a preliminary overview of the main aspects of the FTA recently subscribed to by Guatemala and the US, with attention to the implications in terms of increased market access for Guatemalan products, as well as some of the key legal and institutional consequences ofthe agreement. 150

Market Access and Rules of Origin

5.30 Agriculture: CAFTA commitments in agriculture include a total elimination of tariffs for most agricultural goods with the only exception of sugar for the United States and white for CA (see Table 3). This implies a modest expansion of the current market access granted under the CBI, as new duty free access was obtained on a handlid ofnew products which had been excluded from these preferences such as some fruits and vegetables. Most significantly, the agreement includes the relaxation of tariffs and some non tariff barriers on selected agricultural products of interest to Guatemalan and US producers such as yellow corn, rice, red beans, sorgum, onions, peanuts, meat and dairy products. Tariffs and quotas on most of these products will be phased out within 15-20 years, with grace periods ofup to 10 years. In addition, a special agriculture safeguard (SAS) was agreed to provide temporary protection against sudden surges in imports.

5.31 CAFTA also commits signatory countries to the elimination of export subsidies. In the case of Guatemala, this affects mainly exports of non-traditional agricultural goods and fisheries which have enjoyed different types of subsidies in the past.

Pork Meat 4,148 unlimited

5.33 Manufacturing: By including canned tuna and foot wear, which were excluded from CB preferences, CAFTA grants duty free access to the US market to all industrial non textile exports from Guatemala. On the other hand, Guatemala grants duty free access to nearly 80 percent of US industrial exports. Tariffs for the remaining 20 percent will be phased out within 5-10 years, 151 giving time to those sectors to prepare for competition and to the government to compensate for the potential lost of fiscal revenue. Flexible rules of origin were agreed for inputs like steel which could be imported from third countries, with the final product maintaining its preferential access to the US market.

5.34 For textile and apparel exports, the agreement consolidates the benefits granted under the CBI renewal of 2000 (known as CBTPA) and includes important additional provisions which will contribute to the expansion of exports and value added in Guatemala. CAFTA conditions grant duty free treatment to apparel made from regional (knit or woven) fabric using regional yarn. Under the CBTPA, only some goods using regional fabrics and yarns had duty free access but subject to quantitative restrictions. In addition, the treaty gives duty free benefits (subject to quantitative limits) to apparel made in Central America, using fabrics from NAFTA partners Mexico and Canada. Also, the treaty allows for an expanded use ofthird country inputs without losing the duty free status. This applies to certain fabrics and materials that are in “short supply” in member countries (based on a list developed in consultation with industry in US and Central America), and to some products that undergo a substantial transformation in the region (bras, sleepwear and textile luggage). Furthermore, the share ofthird-country content to go into apparel was increased from 7% (Under CBI) to 10% in CAFTA (‘de minimis’ provision). All these measures, which are retroactive to January I,2004, offer new opportunities for Guatemala to consolidate its apparel industry and to prepare it for the increasingly competitive global market that will arise once the quotas that still regulate world trade are eliminated at the end of 2004.

5.35 Despite initial fears, CAFTA did not include provisions to change current export promotion regimes, in particular, export processing zones. Yet the treaty ratifies compliance with WTO obligations, which requires countries to dismantle fiscal subsidies implicit in those schemes by 20 10.

Government procurement

5.36 CAFTA provisions on this front includes commitments similar to those of NAFTA, with minimum thresholds to trigger competitive bidding and other procurement procedures aimed at ensuring transparency and non discrimination among member countries. The agreement requires fair and transparent procurement procedures, such as advance notice ofpurchases and timely and effective bid review procedures. In addition, strict guidelines are spelled out for when governments can resort to procurement methods other than bidding. CAFTA commits signing parties to make bribery in government contracting a criminal offence.

5.37 CAFTA gives access to Guatemalan firms to bids on contracts for purchases by US federal and state governments, while U.S. firms gain access to bids on contracts from Guatemalan government ministries, agencies and departments. Low value contracts are excluded. In addition to locking-in recent reforms, the agreement will require legal and administrative changes in order to strengthen transparency and efficiency in procurement procedures. Particular emphasis should be given to measures aimed at tackling the sources of corruption, which is a continued charge in public procurement outcomes in most countries in the region. 152

5.38 In the FTA with Mexico, Guatemala, together with El Salvador and Honduras, specifically excluded a chapter on government procurement to avoid NAFTA type commitments in this area. In more recent FTAs, Guatemala together with other CA countries has accepted disciplines, which are less restrictive to those imposed by NAFTA. While Guatemala has made progress in improving transparency and competition in government purchases in recent years, it still lags behind international standards. Most importantly, Guatemala will need to strengthen its processes to avoid continued charges of lack of transparency and corruption in public procurement outcomes.

Propertv Rights

5.39 CAFTA commitments in this area broadly lock in recent reforms implemented by Guatemala intended to improve IPR protection and assure firms from member countries no discriminatory treatment. There are, however, some specific changes to current norms that need to be undertaken, as well as the signing of additional international agreements in order to fully comply with the terms ofthe treaty. Some ofthe key commitments include:

The automatic extension for patents in case of delays in processing of patenting submissions. The agreement requires the protection of confidential information used for patent purposes. It also defines the concept of new products and does not recognize patents for second uses of a previously patented product (for pharmaceuticals). In addition, it requires a system to prevent the marketing ofpharmaceutical products that infringe patents. Preservation of the right to use compulsory licenses for pharmaceuticals to address public health crisis such as HIV AIDS, Requirement of transparent procedures for the registration of trademarks, including geographical indications. Includes new figures in trademark protections such as sound trademarks (marcas sonoras) certification trademarks and smell trademarks (marcas olfativas). Expansion of author’s rights from 50 to 70 years, Protection of new plant varieties, including obligations to ratify the UPOV treaty of 1991. Commitment of signatory countries to make best efforts to ratify a number of international agreements dealing with trademarks, patents, internet, satellite TV and other IPR issues.

5.40 More importantly, CAFTA requires a mores strict enforcement ofIPR norms, an area that continues to be a major problem in Guatemala, with widespread violation of copyrights in video and computer software. The agreement criminalizes end-user piracy and requires the adoption of more efficient legal and administrative procedures to combat and sanction the infringement of IPR. Among other provisions, it requires all parties to authorize the seizure and destruction of counterfeit and pirate goods and the equipment used to produce them. It also provides for enforcement against goods-in-transit to deter violators from using ports or free trade zones to traffic in pirated products. Under CAFTA, non compliance with IPR provisions will be subject to dispute settlement mechanisms which could eventually lead to the imposition of monetary fines. By strengthening the rule of law and overall investment climate, better enforcement of IPR is likely to have a positive impact on investment, especially in sectors such as information technology, pharmaceuticals and agrochemicals. 153

Labor and environmental standards

5.41 CAFTA includes chapters on labor and environmental standards, as mandated by the authorization given by the U.S. congress to the executive branch. The inclusion of such provisions has generated heated public debate about whether they should be included in FTAs and whether they can effectively contribute to improve standards in developing countries.

5.42 While Guatemala has adequate domestic legislation and subscribes to the relevant international treaties in these matters, the problems lies in their enforcement. For instance, Guatemala has been questioned by the ILO and within the CBI review mechanism about potential violations on unionization rights, the lack of enforcement of labor regulations in FTZs, minimum wage regulations and the failure to enforce international commitments to eliminate child labor. The U.S. subjected Guatemala to a special labor review in 2000, which was completed successfully in 2001 with the approval ofthe Labor Code.

5.43 CAFTA commits all signatory countries to enforcing current domestic labor and environmental laws and regulations and bans the relaxation of these regulations to encourage trade and investment. Non compliance is subject to the dispute settlement provisions of the agreement and could eventually lead to monetary penalties, which could be used by the offending party to strengthen its enforcement capacity.

5.44 The labor chapter contains a three part strategy to improve working conditions in Central America by:

0 Ensuring effective enforcement of existing domestic labor laws through commitments of signatory parties, 0 Establishing a cooperative program to improve legislation and enforcement with the support ofthe International Labor Organization, 0 Building capacity of CA nations to monitor and enforce labor rights through specialized consultations and targeted training programs in the areas ofchild labor, public awareness of workers rights and labor inspection systems. It includes an annex on labor cooperation which defines priorities and financing. For the fist year, the U.S committed $6.7 million to educated Central Americans on core labor standards and to improve administrative capacity in labor matters.

5.45 The environmental chapter goes beyond provisions included in the recent U.S. FTAs with Chile and Singapore. CAFTA commits parties to the effective enforcement their own domestic environmental laws through the agreement’s dispute settlement procedures. It forbids the weakening of environmental laws to attract trade and investment and enhances the support of multilateral environmental agreements and organizations. CAFTA includes an environmental cooperation agreement with the following priorities (USTR, 2003):

~~

15* Recent studies suggest that their inclusion is unnecessary since firms engaged in trade are those which better comply with labor and environmental regulations (Stem, 2003). 154

0 Strengthening the capacity to develop, implement and enforce environmental laws; Promotion of incentives to encourage environmental protection; Promotion ofclean production technologies; Building capacity to promote public participation in the environmental decision making process.

5.46 CAFTA commitments are unlikely to require significant changes in current labor and environmental laws and regulations in Guatemala, but will contribute to enhanced enforcement which has long been considered a key weakness. This positive development may contribute to improve the investment climate for exporting activities, particularly the maquila sector, by defusing ongoing criticism of workers’ rights violations, and remove the potential for demand side boycotts.

Other provisions

5.47 Customs and trade capacity building: Customs have been a significant bottleneck to trade expansion in Guatemala, due to lengthy procedures, multiple inefficiencies and opportunities for fraud and corruption. CAFTA includes commitments to improve and modernize custom procedures, facilitate trade among parties, and reduce room for discretion. Guatemala, together with other CAFTA signatories committed to a list of actions within three years to accomplish goals such as the publication of all norms and regulations on the internet, the electronic presentation of certificates oforigin, and the automation of most port operations (automatizacion del despacho de bienes). All parties also agreed to share information to combat the illegal trans- shipment of goods. In addition, the agreement includes for the fist time a Committee on Trade Capacity Building to coordinate and provide assistance to promote economic growth, poverty reduction and adjustment to liberalized trade.

5.48 Despite these actions, Guatemala needs to push ahead with its own agenda for reform in this area in order to maximize the potential impact of trade on development. International comparisons suggest that trade facilitation investments and reforms in Guatemala should focus on improving the customs environment and port efficiency. Customs regulations should be streamlined and made more transparent. Ports require improved regulation, enhancement of competition in port services and modern management practices. The measures spearheaded by Guatemala since January 2004 to speed up the implementation of a Central American Customs Union, such as the installment of 24 hour joint customs posts with El Salvador (and with Honduras in the near future), are steps in the right direction.

5.49 Dispute settlement: CAFTA provides for all core obligations to be subject to a bilateral dispute settlement panel with high standards of openness and transparency. This represents a considerable gain with respect to CBI regulations, which does not allow recourse to unilateral actions by the U.S. The inclusion of monetary penalties to enforce commercial, labor and environmental obligations provide incentives to comply with provisions and strengthening domestic norms and institutions. However, their actual use is unlikely due to long consultation periods and tough tests for non compliance. 155

Overall Evaluation

5.50 CAFTA should not pose serious challenges to Guatemala’s legal and institutional framework, since the country has already modernized its trade regime to a great extent and has adopted disciplines similar to NAFTA in most of the FTAs it has subscribed in recent years, including those with Mexico, Dominican Republic (2001) and the ones currently under negotiation with Canada and Chile. However, as described above, CAFTA will put significant pressure on the upgrading of regulations, modernization of institutions and their enforcement in areas that are important to spur investment. This is indeed a welcome outcome since these are areas in which policy reforms of recent years have shown normative and implementation deficiencies in Guatemala. However, it is important to note that CAFTA alone cannot ensure the modernization of institutions, and in addition countries will need to lead new reform efforts and be willing to allocate the necessary resources to boost the capacity and effectiveness of key institutions. Guatemala should take advantage of the commitments included within CAFTA for cooperation with the U.S. to boost standards and enforcement levels in areas such as labor, environment and customs among others. The Trade Capacity Building Commission created under CAFTA should also aid in the mobilization of human and financial resources from other donors.

Potential Impact of CAFTA for Guatemala

5.51 CAFTA is likely to have a positive impact on the by promoting trade, FDI, technology transfer and ultimately growth and poverty reduction. Trade flows should increase by virtue of lower trade barriers and improved customs procedures. FDI should grow in response to greater private sector confidence and a better legal and economic environment. Technological transfer and increased productivity should be the result ofnew FDI flows, imports and greater overall competition.

5.52 The experience ofNAFTA with the Mexican economy is illustrative for Guatemala. As a recent World Bank study on the subject demonstrate^,'^^ the substantial reduction in tariffs on both sides brought about by NAFTA led to a sharp expansion in trade flows with the U.S., reflected in an increase in the trade openness index from 33.3 percent of GDP in 1994, to 53.1 percent 1995 and 63 percent in 2002. While the same magnitude of trade gains is unlikely for Guatemala, there is considerable scope for trade creation under CAFTA, directly through enhanced access to the US market beyond CBI terms, and indirectly through the impact of greater investment on trade flows. In a dynamic context, the latter could contribute to transform Guatemala’s export structure as NAFTA did with Mexico. Before NAFTA, Mexican exports to the U.S. were concentrated in primary products, including oil. After NAFTA, FDI flows greatly broadened Mexico’s export base with manufactures largely surpassing traditional primary products.

5.53 While trade diversion can be a significant distortion introduced by some FTAs, this is unlikely to be significant with CAFTA. The U.S. is already Guatemala’s largest trading partner and the fact that trade flows with the U.S. have grown over the past decade along with those to

‘59 Lederman, D.; W. Maloney and L. Semen, (2003), Lessons from NAFTA for Latin America and the Caribbean. World Bank. 156 other natural trading partners (e.g., other members ofthe CACM) suggest that there is little scope for trade diversion under CAFTA. 160

5.54 Available empirical evidence also suggests that North-South FTAs (i.e., between developed and developing countries) have a greater impact in terms of export and GDP growth for developing countries, than South-South agreements (Berthelon, 2002; Monteagudo and Watanuki, 2001). This result is explained by the greater potential for trade creation offered by developed countries due to their higher income and level of competitiveness. Furthermore, the lock-in effect of these FTAs is likely to be stronger, contributing to the credibility of trade reforms, which are crucial to promote investment and growth.

5.55 One way to examine the method to quantify potential effects of CAFTA is to assume that it will lead to higher trade flows (as a share of GDP) following the Mexican experience. Using the growth model of Loayza et a1 (2002), it is first assumed that Guatemala will reach by 2010 the magnitude of trade openness (corrected for non-policy factors such as area, population and per capita GDP) that Mexico reached in the 1996-1999 period. In this scenario, the Guatemalan growth rate would be forecasted to grow at an additional 0.77 percent throughout the decade. Even if only half of this value were obtained then the per capita growth boost of greater trade flows would be 0.38 percent annually.

Impact on Agriculture

5.56 As beneficiaries of the CBI since 1983, the majority of agricultural and agro processed products from Guatemala enjoy duty-free access to the US. market. These benefits were extended through the Trade and Development Act of2000 (NAFTA parity) which grants similar benefits to those granted to Mexico by NAFTA. 16’

5.57 In addition, an important number of ‘sensitive’ agricultural products face trade barriers to access the U.S. market. The CBI establishes quotas to products such as meat, dairy, sugar, peanuts, tobacco and cotton and imports above the volume assigned are obligated to pay Most Favored Nation (MFN) tariffs. Other barriers include seasonal tariffs, increased tariffs, automatic licensing procedures and anti-dumping measures which have affected US imports of chocolate, meat products and fruits and vegetables, among others.

5.58 A recent study sponsored by the World Bank found that Guatemala could significantly increase its agricultural exports to the U.S., provided a comprehensive elimination of these barriers takes place under CAFTA. Using the methodology of comparative revealed advantage (Table 3), the study found that Guatemala exhibits comparative advantage in 261 8-digit tariff headings of agricultural and agro-industrial goods. This amounts to total annual exports of $1,236 million during the period 1998-2000, or 80 percent of the total value of agricultural and agro-industrial exports. Of these headings, 18 1 (69%) display comparative advantages in world markets but not in the U.S., and 128 ofthem were identified to face some kind oftrade barrier in

I6O This has been confirmed by recent estimates of trade creation and diversion by the IMF (Alvin Hilaire and Yongzheng Yang, “The United States and the New Regionalism”, IMF Working Paper WP031206) as well as from the partial equilibrium analysis presented in this paper. 16’ The CBI initially excluded canned tuna which had a tariff of 35%. NAFTA parity reduced it to 18% and to 0% from 2008 onwards. (Monge et a1 (2003). 157 the U.S. The products affected by these barriers include frozen seafood, cheddar cheese, honey, fruits (cherries, melons, apples, etc.), oatmeal products, vegetable fats, sugar and sugar byproducts, tobacco products, powdered milk and butter.

5.59 On the import front, tariffs for all agricultural products are scheduled to be phased out under CAFTA with the exception of white maize due to its sensitive nature in Central American economies. Detailed studies need to be made as to the potential effect of free trade with the U.S. on items that have been the subject of tariff peaks in recent years such as yellow corn, rice, beans, beef and poultry. Recent studies by the Bank on this issue for other Central American countries reveal that the changes will yield welfare gains for urban consumers as well as for the majority of the rural population. Negative effects are concentrated in the segment of rural households that are net producers of these items and who represent about a fifth of rural inhabitants. 162

5.60 A significant component of Guatemala’s strategy to take advantage of the benefits of CAFTA should be the design of a strategy to increase production and export opportunities in agriculture. In order for such a strategy to have a strong poverty reduction component, significant attention should be paid to smallholders who are most receptive to changes and who can intensify their production of activities in which Guatemala exhibits comparative advantage. A recent USAID-fundedstudy (Mellor, 2003) indicates that such a strategy for the Altiplano should take advantage of the opportunities for large increases in farm incomes in high-value coffee, horticulture and livestock.

Table 5.4: Guatemala: Comparative advantage and barriers to trade in the US for Agricultural and Agroindustrial products (1) total tariff headings exported to the world with revealed comparative advantage (RCA) 261 (2) total tariff headings with RCA in the world but not in the US 181 % of tariff headings without RCA in the US (2)/(1) 69%

(3) Total tariff headings with barriers to trade in the US 128 % of tariff headings with barriers to trade in the US (3)/(2) 71% Type of Barrier*: Headings excluded from the CBI 57 Headings with domestic subsidies in the US 8 Headings with ad valorem tariffs in the US 25 Headings with specific tariffs in the US 25 Headings with non tariff barriers in the US 26 Headings with export subsidies in the US 66 * The same product could face more than one type of barrier.

I I Source: Monge-Gonzilez; Lorfa, Gonzalez- Vega (2003)

Impact on Manufactures

5.61 To quantify the potential effect of the elimination of US tariffs on Guatemalan exports. Table 4 displays results from partial equilibrium simulations based on market-specific

Claw C. Portner (2003), “Expected Impacts of CAFTA in Guatemala”, mimeo, Washington University. 158

e1a~ticity.I~~The simulations suggest that trade gains from CAFTA would amount to a short- term increase in exports of 47 percent, ($778 m) compared with their 2001 level. As expected, most of the estimated gains would be concentrated in the apparel sector grouped under headings 61 and 62 (99% of total gains), assuming no significant capacity constraints.

Table 5.5: Guatemala: Estimated Effects of US Tariff Elimination CAFTA" Potential Gain Total Actual From From 'hade Exports Total Trade Trade After 2001 Gain Diversion Creation CAFTA" Change Product HS Code and Description ($000) ($000) ($000) ($000) ($000) (Oh) A B=C+D C D A+B BIA Total 1,652,343 777,969 204,989 572,980 2,430,312 47.08 HS.61 Art of apparel & clothing access, knitted 880,543 514,248 132,420 381,828 1,394,791 58.40 HS.62 Art of apparel & clothing access, not knitted 743,844 255,137 67,304 187,833 998,981 34.30 HS.24 Tobacco, manufactured tobacco substitutes 8,185 4,673 3,637 1,035 12,857 57.09 HS.63 Other textile articles; sets; worn clothing 5,223 1,322 711 61 1 6,545 25.32 HS.64 Footwear, gaiters and the like 2,954 1,241 322 919 4,195 42.02 HS.42 Articles of leather; saddleryiharness 863 282 76 206 1,146 32.67 HS.52 Cotton 1,063 232 124 108 1,295 21.85 HS.65 Headgear and parts thereof. 1,599 188 53 136 1,787 11.77 HS.55 Man-made staple fibres 540 170 85 84 710 31.41 HS.54 Man-made filaments. 470 162 87 74 632 34.39 HS.21 Miscellaneous edible preparations. 3,120 110 62 48 3,230 3.53 HS.17 and sugar confectionery. 2,387 87 47 40 2,474 3.65 HS.56 Wadding, felt & nonwoven; yarns; twine 1,005 74 39 35 1,079 7.34 HS.58 Special woven fab; ace; tapestry 116 22 12 10 138 18.52 HS.46 Manufactures of straw, esparto/ 192 9 5 5 202 4.92 HS.18 Cocoa and cocoa preparations. 164 5 3 2 169 3.21 HS.94 Furniture; bedding, mattress, matt support 37 3 1 2 40 8.01 HS.51 Wool, fineicoarse animal hair, horsehair yarn 8 2 1 1 9 21.13 HS.57 Carpets and other textile floor coverings. 13 1 0 0 14 5.15 HS.59 Impregnated, coated, coverilaminated textile 6 1 0 0 7 10.27 HS.39 Plastics and articles thereof. 6 0 0 0 6 2.81 C 1 <7 HS. 19 Prep.of cereal, flour, starch/milk; pastry 5 n n n J 1.JI - - - I Source: Estimations using SMART, exports from UNCOMTRADE, tariffs from TRAINS, adjusted by utilization rates of CBI's preferential tariffs. * CAFTA estimated as an unilateral tariff elimination by the US to Central American countries.

5.62 These results need to be interpreted with caution. While the use of utilization rates of trade preferences is an improvement over traditional analysis of potential apparel gains, simulations cannot easily deal with the complicated structure of export restrictions associated with rules oforigin requirements that are likely to be in place in CAFTA for this industry. As for other countries in the region, the greatest potential for expanded Guatemala apparel exports lies in a loosening up of current rules of origin. For instance the current quota for knitted apparel made from regional inputs could be expanded to include all types of apparel and other textile- using products. In addition the rule of origin associated with this quota could be less restrictive

'63 Results calculated with SMART software. 159 by establishing products that qualify for tariff free status if component fabrics originate in the CAFTA region. Reforms along these lines could attract investment into yard spinning, fabric making and other related processes for fabrics and apparel into Guatemala that could greatly increase local value added in this sector. Similarly, Guatemala may also benefit from a flexible “short supply” provision that allows for duty-free exports with inputs from third countries, as already included in CAFTA.

5.63 Hopes for expanded apparel exports from the region face significant uncertainties given that from the end of the MFA in January 2005 all textile quotas among WTO members will be eliminated. At that point it is expected that countries with strong absolute comparative advantage like China may sharply increase their exports to the U.S. market, to the detriment of higher cost participants. But even under a complete elimination of quantitative restrictions on apparel trade, Guatemala and other CA countries are likely to continue to enjoy a significant tariff advantage (i.e,, zero tariff vs. 10-30% MFN tariffs in apparel categories) over Asian competitors. In addition, CA countries benefit from a distance advantage, which provides them with a competitive edge in markets where fashion trends change rapidly and just-in-time deliveries and rapid supply responses are important. These factors together with the ‘know how’ capabilities developed and the specialization on “full package” services by Guatemalan apparel exporting firms should create significant opportunities for development of local linkages for this cluster, beyond the pure assembly model associated with maquila.

5.64 With respect to non-apparel manufactures partial equilibrium simulations do not reveal significant gains aside from maquila products. However these simulations traditionally underestimate the supply response to FTAs because they cannot anticipate new exports aside from those for which exports already exist. Simulations made for Mexico before NAFTA also underestimated the expansion of new export categories for the same reason. Before NAFTA, Mexican exports to the U.S. were concentrated in primary products, such as oil, whereas after NAFTA Mexico’s export base broadened substantially, with manufactures largely surpassing traditional primary products.

Impact on Investment

5.65 CAFTA is also expected to encourage investment including FDI flows to Guatemala, although the magnitude of such flows is difficult to anticipate. Investors are likely to be attracted by the new profit opportunities brought about by CAFTA, and more significantly by the credibility effect (or reduced risk) that CAFTA is likely to introduce. This credibility effect has been found to be a critical factor in Mexico, where the lock-in of trade policies and broader reforms (ranging from regulation and competition policies, to property rights, contract enforcement, and macro stability) and the guarantee of access to partners’ markets have contributed to the rapid growth in foreign and domestic investment. Furthermore empirical analysis has confirmed that FDI flows react positively to FTAs, particularly in the initial stages. In the case of CA however this effect is not expected to be as significant in the short run, since most countries in the region have unilaterally liberalized their FDI regimes and have already subscribed investment protection treaties with the U.S. 160

Impact on Public Finances

5.66 Despite overall tariff reduction, in 2002 import duties accounted for nearly 11 percent of total Central Government revenue. Assuming an extreme scenario where all tariffs on imports from the US are eliminated and volumes remain constant, fiscal losses for Guatemala (tariffs + VAT on such tariffs) have been estimated to be about 5 percent of current revenues (Perry, Lederman y Suescun, 2002). However, given the gradual phase out of some tariffs and the potential for greater import volumes and overall growth, the net effect in the first years of CAFTA implementation is likely to be lower. Compensatory fiscal measures may be required, especially if import volumes do not change significantly, if the additional fiscal revenues from greater growth do not materialize, or if the costs of implementation and enforcement of CAFTA commitments turn out to be higher than expected.

Recommendations: Actions to Maximize CAFTA Opportunities

5.67 CAFTA is a promising initiative for Guatemala to expand trade levels, boost investment and growth and reduce poverty. CAFTA is likely to enhance market access to some Guatemalan products, while making permanent the unilateral preferences offered in the past through CBI preferences. Additionally, the more comprehensive nature of CAFTA is expected to ‘lock in’ broad reforms and send a strong signal to investors. However, CAFTA alone is not enough to generate a large investment and growth response, as argued in the recent Bank study “Lessons from NAFTA” (Lederman et. al., 2003), which identifies a number of critical gaps that have limited some of Mexico’s gains (see Box 1). Lessons from the Mexican experience and others indicate that Guatemala needs to advance in key policy and investment areas to ensure that CAFTA’s potential for economic and social development can materialize.

5.68 In order to identify the most important areas for policy changes it is helphl to review the key factors that facilitate the attainment of the static and dynamic gains from trade reforms and FTAs. On the static front, gains depend on the ability of the economy to successfully adjust to changes in relative prices. This entails the restructuring of the economy, including the movement of labor to those sectors where labor productivity is higher. On this front, institutions and regulations that facilitate resource mobility and firm entry and exit are critical, as well as infiastmcture and other trade facilitation areas.

5.69 On the dynamic front, international evidence suggests that trade policy changes or FTAs can have a significant impact on aggregate investment and technological progress. On this front, the key determinant is the economy’s ability to take advantage of foreign technologies, which involves boosting the education and skills level of the labor force and setting up institutions and regulations that facilitate the importation of new technologies and their adaptation to the Guatemalan context.

5.70 Actions needed to obtain the most from CAFTA and ensure static and dynamic gains tend to coincide broadly with the agenda spelled out in this CEM to enhance growth. In order to optimize CAFTA’s trade and growth gains, key complementary policies should include:

A. Education and knowledge absorption and generation: CAFTA is likely to bolster FDI and imports with the capacity to improve technology and productivity. However to reach hll 161 potential and enhance technological spillovers sufficient levels of human capital are needed. In education this means that Guatemala needs to close its ‘skills gap’, by expanding coverage and quality of its primary and secondary schooling system (as explained in Chapter I1 of this report). It will need to boost the quality of its research institutions, increase expenditures on R&D and develop links between public research and the private sector (see Chapter IV). Thus there are important synergies to be exploited between a functioning, innovative system and critical higher education initiatives.

B. Infrastructure and trade facilitation: Deficiencies in Guatemalan infrastructure such as road networks and ports need to be addressed to reap the potential gains of CAFTA (see chapter I11 of this report). In the area of trade facilitation, Guatemala should focus on improving the customs environment and port efficiency. Customs regulations should be streamlined and made more transparent. Ports require improved regulation, enhancement of competition in port services and modern management practices.

C. Institutional development and governance: Serious deficiencies still exist in Guatemalan institutions and governmental structures, particularly regarding corruption, the rule of law and personal security (see Chapter 111). These governance weaknesses are part of the reason for the low growth yield of reforms throughout Latin America in recent years. To reap the rewards of CAFTA, continued improvement in institutions is required, especially those aimed to improve the rule of law and fight corruption. This will require substantial local efforts, as such improvements have not been automatic byproducts ofNorth-South free trade agreements.

D. Facilitating the transition: Attention is also required to ensure that the transition to new relative prices is not accompanied by a large increase in temporary unemployment. In particular, for poor households highly dependent on sensitive agricultural commodities, technical assistance programs will be required to facilitate technological upgrading, crop substitution or assistance in moving out of agriculture, complemented by actions to spur the development of deeper financial markets. This process should be facilitated by the grace periods ofup to 10 years before tariffs begin to drop for sensitive crops that were accorded in CAFTA. In addition, to ensure that benefits spread beyond large companies, actions to support SME will be required, particularly in expanding their access to finance.

E. Macro-fiscal management: Strengthening of macroeconomic policies and debt sustainability is an important component ofthe strategy to improve the investment climate in Guatemala. The agenda should focus on obtaining the required consensus to increase government revenues to levels that are consistent with the Peace Accords and that may boost significantly required social expenditures while retaining some flexibility in fiscal policy to allow the pursuit ofeffective counter cyclical policies (Perry et. al., 2003).

F. Trade policy: In addition to strengthening institutions related to meeting CAFTA commitments in the trade administration sphere, Guatemala is likely to benefit from continuing to pursue its agenda ofunilateral, bilateral and multilateral actions to expand trade and broader integration opportunities. Deepening trade and other links with regional neighbors through the CACM will improve allocation of resources in the region and provide 162

economies of scale needed to launch new viable export ventures (like the recent customs union with El Salvador). Further progress in reaching FTAs with Canada, the European Union and with other Latin American countries through FTAA will further broaden economic integration and minimize any possible trade diversion effects from existing FTAs. A related issue is the continuing international pressure for the removal of tax incentives in free trade zones. In the medium run, Guatemala will need to replace these incentives by an improved investment climate that can compensate for lost advantages to established firms.

Box 5.1: The Lessons from NAFTA

A recent study on the "Lessons from NAFTA for Latin America and the Caribbean" by Daniel Lederman, William Maloney, and Luis Serven (World Bank, 2003) highlights the following lessons:

NAFTA can be credited for boosting Mexico's growth in the post 1994 period. By inducing a reciprocal reduction in trade barriers and locking-in the reforms of recent years, it has yielded a positive impact on trade flows, foreign direct investments, and growth of industrial productivity. It is also responsible for the creation of many new jobs and some reduction in poverty rates of recent years in Mexico. Despite the positive growth effect, NAFTA has not sufficed to guarantee income convergence among North American countries. This reflects mainly pending items in Mexico's policy agenda including institutional gaps (Le., corruption and rule of law), deficiencies in education (both coverage and quality), a passive innovation policy, the lack of critical infrastructure (especially in lagging regions) and some weaknesses in macroeconomic policy. The experience has demonstrated that while positive, an FTA with a developed partner is not sufficient to increase growth on a sustainable basis unless an agenda of complementary reforms is pursued. NAFTA benefits have been concentrated in states in the North and Center of Mexico. Southern states have not seen much of an impact, due to key deficiencies in institutions, education and infrastructure. Contrary to some predictions, NAFTA has not had a devastating effect on Mexico's agriculture. In fact, both domestic production and agricultural trade rose during the NAFTA years. The negative effects did not materialize because aggregate demand expanded rapidly in both Mexico and the U.S. in the latter half of the 1990s, some segments of Mexican agriculture recorded substantial increases in productivity (esp. imgated lands), and outdated subsidies were transformed into targeted efficient programs (e.g., Procampo) which delinked transfers to farmers from current and future production levels. Mexico's experience also shows that there are some key remaining barriers to trade that have limited the growth potential of certain sectors. In particular, restrictive rules of origin affecting clothing exports to the U.S. market seem to have limited the ability of Mexican exporters to take full advantage of NAFTA preferences. This issue is likely to be a key topic for El Salvador and other Central American countries. Annex A Page 1 of 7

ANNEX A

The Key Determinants of Growth in Guatemala

1. This annex estimates the influence of economic policy outcomes on growth based on the results of a comprehensive cross-country study carried out by Loayza, Fajnzylber and Calderon (2002). That study regressed the economic growth performance of individual countries against a variety of economic, political and social variables. Broadly speaking, such a relationship can be expressed as:

where variable, Yi, denotes the rate of per-capita GDP growth in country i during period t, and Xit denotes to the vector of explanatory variables, et is a vector ofrandom errors, and a and p are the equation parameters to be estimated. Assuming that there exists a stable relation between the explanatory variables and per capita GDP growth, it is then possible to trace Guatemala's performance in Y to shortcomings in X or to country specific shocks.

2. The study by Loayza, Fajnzylber and Calderon (2002) carries out this regression analysis using panel data from 78 countries for the period from 1960 to 1999.' The twelve explanatory variables were chosen on the basis of attention received in the academic literature and policy circles, as well as the robustness exhibited in previous empirical studies when tested in combination with other variables. These explanatory variables fall into five categories: a transitional convergence factor (represented by the initial level of GDP per capita), which captures the notion that richer countries grow faster than poor countries, other things equal, because of decreasing returns to scale in production functions; a cyclical reversion term (given as the gap between actual and potential output), which captures the tendency, typical of business cycles, for growth to revert to a trend level after periods of above or below-trend growth; structural policies and institutions (comprising indexes that measure educational attainment levels, financial depth, trade openness, government consumption, and public infrastructurel2; stabilization policies (comprising indexes to measure lack of price stability, output volatility, real exchange rate overvaluation and the prevalence of systemic banking crises); and external conditions (captured by the growth in the terms of trade and period-specific shifts that proxy for general world growth).

~ ' Different panel data sets are used in the regressions, depending on whether the data is averaged over the entire sample, over 5-year or 10-year intervals. The regression results are presented in Table 11.3 of Loayza et a1 (2002). ' Loayza et a1 (2002) initially had also included a measure of governance among the explanatory variables, but this was subsequently dropped because none of the different governance indexes used tumed out to have a statistically significant impact on growth (and sometimes exhibited the wrong sign). Annex A Page 2 of 7

3. It is important to note that the structural and stabilization policy variables used in the regressions described above refer to policy outcomes or results, rather than to policy settings or reforms. For instance, the trade openness variable is the volume of trade (exports + imports) over GDP, rather than some index oftariff rates or quantitative restrictions. Similarly, the index used to measure the coverage of public infrastructure is the number of fixed telephone lines per capita, rather than some index of success in privatization or strengthened regulatory capacity. In general, one expects GDP growth to be more closely related to policy outcomes than to policy settings or reform^.^ On the other hand, the use ofpolicy outcomes in the analysis requires that a link be established between specific policy measures or instruments and particular outcomes, before these analytic results can be translated into concrete policy advice.

Explainingpast changes in growth

4. Changes in per capita growth over different periods can now be explained with the estimated parameters of regression Equation (A. 1). This is done by differencing Equation (A. 1) as

A.2) (Yit - Yit-1) = p(Xit - Xit-I) + (eit - eit-i), and inserting the actual values of the differenced explanatory variables. Annex Table A1 summarizes the results presented in Loayza, Fajnzylber and Calder6n (2002) for the Central American countries for the 1980s and 1990s. The first set of results in Annex Table A1 looks at the change in average per capita GDP growth observed in the 1990s vis-a-vis the 1980s. Guatemala averaged 1.43 percent annual per capita growth in the 1990s, compared to an average annual decline of 1.62 percent in the 1980s. The actual difference between both rates, 3.05 percent per annum, is relatively close to the change predicted by the regression equation, which is 2.44 percent. This predicted change in per capita growth is obtained by adding up the effects of changes in the transitional convergence factor (0.29%), the cyclical recovery factor (0.08%), structural and institutional policy settings (1.45%), stabilization policy settings (0.37%), and external conditions (0.25%). This empirical outcome indicates that improvements in structural and institutional outcomes - specially in education, government consumption and public infrastructure - were the main factors contributing to the increase in Guatemala’s growth rate in the 1990s, vis-a-vis the 1980s.

5. It is comforting to observe in Annex Table A1 that the predicted changes in growth rates for the 1980s and 1990s have the same sign as the changes in actual rates, which indicates that the changes in growth rates over time are not exclusively attributable to random shocks. Looking back at the general growth decline Guatemala had during the 1980s in structural and stabilization policies, Annex table A1 (2nd panel) reveals that the main factors for this outcome were diminished trade openness and greater government consumption in 1980s compared to those in the 1990s. Still, Guatemala was the second country in Central America, after Honduras, that achieved the most important gains on the structural front during the 1980s, as did also, to a lesser

Eduardo Lora, ‘‘Structural Reforms in Latin America under Scrutiny” (Inter-American Development Bank, March 2002) reports the results from a similar set of regressions that use policy settings and reform indexes as the explanatory variables. As expected, the regressions in Loayza et a1 (2002) exhibit a better fit than those in Lora (2002). Annex A Page 3 of 7 extent, Costa Rica and El Salvador. In Nicaragua and Panama the decline of growth in the same decade reflected a deterioration in structural outcomes and particularly, those associated with stabilization policies.

6. The overall pace of structural and institutional improvement exhibited by Guatemala during the 1980s was sustained and surpassed in the 1990s, which saw a general improvement in the structural and stabilization policy outcomes. The overall progress made by Guatemala on both fronts was less aggressive than that shown by El Salvador and Nicaragua but larger than the other two Central American countries and Panama. As a result, El Salvador and Nicaragua were able to boost their average per capita growth rates by more than 2 percentage points through improved structural and institutional outcomes, whereas Guatemala improved its annual growth by 1.45 percentage points on this account.

7. To summarize, Guatemala’s growth was held back during the 1980s by a generally unfavorable external environment, despite positive structural and stabilization policy outcomes. In the 1990s’ Guatemala was able to take advantage of positive external conditions, and much improved structural and institutional policy settings, which resulted in a 3.05 percent growth of per capita GDP from the 1980s to the 1990s.

Simulatingfuture changes in growth

8. Looking now toward the hture, estimated Equation (A.2) can be used to forecast hture growth rates on the basis of forecasted values of the explanatory variables. This is done in Annex Table A2 under two different scenarios concerning the evolution of the explanatory variables. The first scenario broadly assumes that the explanatory variables evolve according to their historical trends4 The second scenario is more optimistic in assuming the implementation of policy reforms, such that the policy determinants of growth in each country move to the top 25th percentile oftheir distribution in Latin America and the Caribbean. Annex Table A3, which follows directly from Annex Table A2, shows the marginal gains in projected growth from embarking on different reform scenarios instead ofmaintaining the historic policy trend.

9. The first panel of Annex Table A2 shows that Central America on average would be projected to grow almost one percentage point faster per year if the historic policy trend is maintained. (This growth increase is determined by policy outcome improvements, which contribute 1.57 percent per year, together with adverse external and cyclical factors, which subtract 0.61 percent per year.) Guatemala, however, would only be projected to growth faster by 0.77 percent per annum if policies were to follow historic trends. This outcome reflects Guatemala’s uneven progress on the structural front in past years. In any case, under this

The historic trends are calculated by Loayza, Fajnzylber and Calderdn (2002) with the use of univariate ARMA regression models (in linear, logarithmic or quadratic specifications). This is used for all variables except for (i) the transitional convergence term, where data for 2000 is used for the initial GDP per capita level, (ii) the prevalence of banking crises, for which a multivariate probit model is used to estimate the probability of such crises on the basis of other forecasted variables, (iii)the change in inflation rates, output gaps and output variability, which are based on projections from the Latin American Consensus Forecasts and World Economic Outlook, and (iv) the period shift, for which it is simply assumed external conditions (other than the terms of trade) will remain the same in the 2000-10 as in the 1990s. Annex A Page 4 of 7

scenario, Guatemala’s per capita income would only be growing by a little over half a percentage point per year during the next decade.

10. Consider now the more optimistic policy reform scenario in the 2ndpanel of Annex Table A2. For the average country in Central America, advancing its structural and stabilization outcomes to the top 25 percent of the LAC region would represent a growth gain of 2.24 percent per annum, which is close to the average gain for all LAC countries (2.20 percent). For Guatemala, the gain would be considerably higher (3.61 percent). This scenario represents a significant advance for Guatemala, raising its annual per capita growth rate from a projected 2.2 percent under the historic trend scenario to 5.04 percent.

11. To achieve the adjustments assumed under this scenario, Guatemala would have to devote most of its reform effort to the expansion of education and of public infrastructure. Improvements in these two areas account for the lion’s share of the total projected increased in growth, equivalent to 2.76 percentage points. This is much higher than the average impact projected for these two policy sectors in Central America (1.42 percentage points) or LAC (0.99 percentage points). Since the impact on growth from each determinant simultaneously reflects the size of the coefficient in the growth equation and the simulated change in the explanatory variable, a relatively high growth impact from improvements in a given policy area compared to the average regional impact is indicative of how far a country lags behind its neighbors in these policy areas. The preceding results, therefore, suggest that Guatemala is furthest behind its neighbors in terms of education attainment levels and public infrastructure, and that catching up in these two areas would yield the greatest growth payoff, By way of comparison, the simulated improvement in stabilization policies would only generate a relatively modest growth improvement of 0.08 percent per annum, which reflects the fact that Guatemala’s policy settings in this area are already very near the 75‘h percentile ofthe distribution in LAC. The same applies to the simulated improvements in the other structural policy determinants, in which Guatemala does not appear to lag behind by LAC standard^.^

12. It remains an open question whether the simulated structural and institutional improvements, especially for the education and public infrastructure sectors, are feasible. In this regard, it is useful to notice that the simulated increase in education attainment levels leading to a 1.67 percent annual growth increase over 2001-10 isjust a modest amount greater than the 0.67 percent increase achieved by Guatemala during the decade of the 1980s (shown in Annex Table Al). The simulated improvement in public infrastructure to boost growth by 1.09 percent, on the other hand, is significantly higher than the historic increases achieved in Guatemala during the 1980s or 1990s, and does not seem to have had recent precedents in other Latin American countries. (The best LAC performers in the public infrastructure area, Chile and Jamaica,

These observations are broadly consistent with the policy-focused findings of Eduardo Lora, “Las Reformas Estructurales en America Latina: Que se ha reformado y como medirlo”, Inter-American Development Bank, Working Paper No. 462, December 2001. Lora’s paper constructs five indexes of structural reform, (trade policies, financial policies, fiscal policies, labor policies and privatization), the first three of which bear a rough correspondence to the outcome-based variables used in the regressions performed by Loayza et al (2002); Le., trade openness, government consumption, and financial development. It also presents an overall index consisting of a weighted average of these separate indexes. Honduras ranks slightly below the LAC regional average in terms of the overall index, is near or above the average in terms of trade policy and fiscal policy settings, and below the LAC average in the quality of financial policies and labor policies. Annex A Page 5 of 7 achieved improvements with a growth impact of 0.79 percent and 0.86 percent during the 1990s.)

13. Although the simulated policy changes would generate a level of growth that would permit the country to make significant advances in reaching Millenium Development Goal targets, questions remain about the feasibility of achieving those policy settings during the next decade. The contemplated increase in education to boost growth 1.23 percent would clearly require a greater effort than that mustered in the 1980s. The simulated increase in private sector credit (as an indicator for financial development) to achieve a significant growth impact does have a precedent in Bolivia, which raised growth by 0.80% through this channel in the 1990s, and Uruguay, which raised growth by 0.66% in the 1980s (though this latter expansion was partly reversed in the 1990s).

Main Conclusions

14. The preceding analysis identified four broad areas (human capital, public infrastructure, financial market development and trade openess) where Guatemala appears to be lagging significantly behind in its development vis-a-vis other Latin American countries and the rest of the world, and where policy advances could have potentially great payoff in terms of raising growth. Of course, this does not mean that the other growth determinants can be ignored or neglected. For example, even though setting the outcome variables (Le, inflation, cyclical volatility, etc.) associated with stabilization policies to the 75th percentile of their world distribution would only be expected to generate a modest improvement in growth in Guatemala, allowing those policies to slip could have disastrous consequences in terms yielding a growth decline.6 Rather, what it means is that Guatemala has been managing these other policy areas reasonably well by world and regional standards, and would do well simply by maintaining the historic trend. However, staying on its historic trend in all policy areas would leave Guatemala on an unacceptably slow growth path, so additional efforts need to be exerted in some areas to bring about faster growth. The preceding discussion suggests that this additional effort would have its greatest impact on growth if invested in human capital development, public infrastructure development, financial market development and trade process.

In fact, Honduras experienced a significant fiscal deterioration in recent years, as the overall fiscal balance moved from a surplus of 1.8 percent of GDP in 1998 to a deficit of -4.6 percent in 2003. In the absence of corrective measures, this would have destabilizing consequences that reduce investor confidence and slow down growth further. mmumhm -$C?t"-? 000000

REFERENCES

Alvazzi del Fratte, Victims of Crime in the Developing World, paper 57, UNICRI, 1998.

Alvin Hilaire and Yongzheng Yang, “The United States and the New Regionalism”, IMF Working Paper WP03/206).

Asociacion de Investigacion y Estudios Sociales (ASIES), XVII Encuesta Empresarial, June 2003.

Asociacion de Navieros de Guatemala, “Planteamiento para un Efectivo Desarrollo Maritimo y Portuario Nacional”, September 2003.

Business Software Alliance, June 2003. Eight Annual Global Software Piracy Study. Trends in Software Piracy, 1994-2002.

Centro de Investigaciones Econ6micas Nacionales (CIEN), Estudio sobre la magnitud y el coste de la violencia en Guatemala, May 2002.

CIEN, Estudio sobre la magnitud y el costo de la violencia en Guatemala. Asociaci6n de Investigacion y Estudios Sociales, June 2003. XVII Encuesta Empresarial, Guatemala, May 2002.

Claus C. Portner, “Expected Impacts of CAFTA in Guatemala”, mimeo, Washington University (2003).

Comision Nacional de Energia Elkctrica (CNEE), Informe de Labores 2002-2003, Guatemala.

Fajnzylber, P., D. Lederman and N. Loayza, “Crime and Victimization. An Economic Perspective”, The Journal of the Latin American and Caribbean Economic Association, 2000.

Findley, Andrea L. and Martha Maria Salgado, “Microcredit in Central America, A Market Study”. Katalysis Partnership. Data collected May-June, 2000.

Foster, V. and C. Araujo, Does Infrastructure Reform work for the Poor? A case study from Guatemala, Background Paper for the Guatemala Poverty Assessment 2002, December 2001.

Fundacion Arias para la paz y el progreso humano, El arsenal invisible. Armas livianas y seguridad ciudadana en la posguerra centroamericana, 2001.

Fundacion Solar, Sustainability ofpower sector reform in Latin America: the reform in Guatemala, Working paper, IDB, May 2002. Hall R. and C. Jones (1 999); Dollar and Wolf (1 997); Hall, R., and C. Jones, (1997), “Why Do Some Countries Produce So Much More Output Per Worker Than Others?”, Quarterly Journal of Economics 114(1) 83-1 16.

Dollar, D., and E. Wolf (1997), ‘‘Convergence of Industry Labor Productivity Among Advanced Economies, 1963-1 982”, The Economics ofProductivity, United Kingdom, Elgar.

Henderson, V., The effect of Urban Concentration on Economic Growth, WP 7503, National Bureau ofEconomic Research, 2000.

“Inequality in Latin America and the Caribbean: Breaking with History?”, World Bank, 2003.

Instancia Coordinadora de la Modernizacih del Sector Justicia, cited by Pasara, Reforma y desafios de lajusticia en Guatemala, CEJA-INECIP, Buenos Aires 2003.

Kaufmann, D. A. Kraay and M. Mastruzzi, Governance Matters 111: Governance indicators for 1996-2002, The World Bank, 2003.

Levine, Ross (1997), “

Lederman, D.; W. Maloney and L. Serven, (2003), Lessons from NAFTA for Latin America and the Caribbean. World Bank.

Ley de Propriedad Industrial, Decreto No. 57-2000, issued in August 2000

Ley de Derecho de Autor y Derechos Conexos, Decreto Ley No. 33-98, which entered into force in June 1998, and was amended by Decree No. 56-20000 from November 2000.

Londoiio, J.L. and R. Guerrero, Violencia en Amkrica Latina. Epidemiologia y Costos, Documento de Trabajo R-375, IDB, 1999.

Londoiio, J.L. and R. Guerrero, in Violencia en America Latina. Epidemiologia y Costos, IDB, documento de trabajo R-375, 1999.

McGraw-Hill annual surveys over a number ofyears, quoted by Rosenberg, N., Uncertainty and Technological Change, 1994.

Moser, C. and B. van Bronkhorst, Youth Violence in Latin America and the Caribbean: Costs, Causes, and Interventions, LCR Sustainable Development Working Paper No. 3, Urban Peace Program Series The World Bank, August 1999.

Moser, C. and C. McilWaine, Violence in a Post-Conflict Context: Urban Poor Perceptions from Guatemala, The World Bank, 2001. PNUD, Guatemala: Una Agenda para el Desarrollo Humano, Sexto Informe Nacional sobre Desarrollo Humano, 2003.

Prensa Libre, Informe: Doscientos obstiiculos a la inversion, December 5th, 2003

Religious Task Force on Central America and Mexico, Central America / Mexico Report, March 2003.

Rodgers, D. Youth Gangs and Violence in Latin America and the Caribbean: a Literature Survey, LCR Sustainable Development Working Paper No.4, Urban Peace Program Series, The World Bank, August 1999.

Rodriguez, M., Diagnostic0 sobre la situacion actual de las armas ligeras y la violencia en Guatemala, Consejo de Investigaciones e Informacion en Desarrollo (CIID).

Romero, E. and J. Barahona, Reporte de Seguimiento a la Reforma del Sistema Aduanero de Guatemala, INCAE, June 1997.

The World Business Environment Survey, 2000

Van Ark, B., R. Inklaar, and R. H. Mc Guckin, 2002,“ Changing Gear: Productivity, ICT and Service Industries: Europe and the United States,” paper presented to Brookings Workshop on Services Industry Productivity, Washington, D.C., May 17.

World Bank Guatemala Skills, Technology and Productivity Survey (1998).

World Bank. Project Appraisal Document - Guatemala Competitiveness project (2000).

World Bank Report , February 2000, Guatemala, Expenditure Reform in a Post-Conflict Country, 19617-GU.

World Bank, 2003. “Guatemala: A Study on Student Achievement In Primary Education”

World Bank, Judicial Reform Project. Loan No. 4401-GT.

World Bank, Doing Business, 2004.

World Bank, June 2003. Guatemala: Private Participation in Infrastructure, Implementation Completion Report, SCL-41490, Technical Assistance Loan.

World Bank (2003), “Closing the Gap in Education and Technology,” The World Bank Latin American and Caribbean Studies, Washington, D.C.

World Bank, February 2003. Poverty in Guatemala, Report 24221-GU.