ASSESSMENT AND RECOMMENDATIONS – 17 Assessment and recommendations Assessment 1. Morelos’ economy is relatively diversified The geographic position of Morelos in the centre of Mexico is an asset for development The state of Morelos, with its population of 1.9 million inhabitants, is one of the smallest in Mexico. The state is located in the centre of the country just south of the metropolitan area of Valle de Mexico, within close reach of the capital Mexico City. GDP per capita, however, is below the Mexican average and less than half of the GDP per capita in Mexico City. Most of the state’s population, more than 80%, lives in metropolitan areas, making it one of the most urbanised states in Mexico, with a population density of 388 inhabitants per square kilometre. The largest city, Cuernavaca, however represents only one-fifth of the state’s population. Proximity to Mexico City is a benefit to the economy, but it is also a challenge The proximity to Mexico City, one and a half hours by bus from the centre of Cuernavaca (the capital of Morelos) to the centre of Mexico city, provides easy access to business services and facilities (e.g. international airports) that Morelos cannot offer, and represents an important market for the tourism sector reliant on the abundance of natural and cultural amenities. The natural landscape together with good climate conditions are among the major drivers of a vast second-home market for residents of Mexico City. Nevertheless, the proximity to Mexico City could also be a challenge for economic development by contributing to pollution and transport congestion in the region as the main motorway connecting Mexico City to the pacific coast (Acapulco) crosses the state from north to south. It also represents a bottleneck for the access to North American markets, as the only road corridor is through the very congested Federal District. In addition to services, the state has a well- developed manufacturing sector, and… The economy of Morelos remains specialised in the manufacturing sector. The share of GVA produced by the manufacturing sector in Morelos is larger than the share at the national level, denoting the relative importance of this sector for the economy. The specialisation index doubled since 2003, and the share of GVA produced by the manufacturing sector reached 23.4% in 2013. This manufacturing legacy is reinforced by the increase in FDI over the period 2011-15. More than three-quarters of FDI comes from OECD member countries, with the United States alone accounting for more than half of FDI in 2015. This stream of investments and the presence of a long established OECD TERRITORIAL REVIEWS: MORELOS, MEXICO © OECD 2017 18 – ASSESSMENT AND RECOMMENDATIONS manufacturing sector represent an opportunity for improving the competitiveness of the economy of Morelos. …youth demographic premium is a potential asset for the economy The population structure in Morelos presents a pyramid-shape with more people under 19 than over 65. The share of the population under 15 over the total working age population (youth dependency ratio) is considerably higher than the OECD average (41.2% compared to 27.5% respectively in 2014). In contrast, the elderly dependency ratio (population over 65 divided by the working age population) stands at 11.38%, compared to 24.17% in the OECD on average. The large share of young people in Morelos represents a workforce potential that can be deployed in the future development of the regional economy. However, realising this workforce potential will depend on access to, and the provision of, high quality basic education for all young people across the state. The presence of prominent research facilities has not been fully exploited yet The Mexican economy underperforms in terms of innovation activity. The share of research and development expenditure as a share of GDP in 2012 was 0.42%, much lower than the OECD average of 2.34%, with countries like Korea topping the ranking with 4.36%. Within this framework, Morelos records a level of patent intensity not only above national average, but also above the level of comparable regions such as the state of Aguascalientes. This prominent research activity is mainly financed by public funds and conducted in public research institutes and universities. The private sector is latent, as reflected in low private R&D investments, and rarely collaborates with research institutes. This may be a reason why Morelos’ public research activity has not translated into productivity growth. 2. Morelos faces some development challenges Morelos’ declining productivity constrains opportunities for inclusive growth, but productivity is picking up in recent years… The economy of Morelos is not performing to its potential, both in terms of GDP per capita and labour productivity growth. GDP per capita was USD 11 613 in 2013, unchanged from USD 11 737, the value in 2003. Labour productivity decreased at an annual average rate of 1.2% over the same period. Other Mexican states experienced a negative or null growth of labour productivity in the same period, which may indicate the presence of common bottlenecks or a country-wide effect. However, Morelos’ productivity performance has been remarkably lower than that of similar Mexican regions such as the states of Aguascalientes (+0.6%), thereby suggesting the presence of bottlenecks in the state of Morelos. Since 2010, the productivity trend started to recover, positioning Morelos as one of the fastest catching-up states in Mexico in the period 2010-13. This trend needs to be further sustained in order boost the competiveness of the regions over the medium and long term. OECD TERRITORIAL REVIEWS: MORELOS, MEXICO © OECD 2017 ASSESSMENT AND RECOMMENDATIONS – 19 …a low skilled labour force and large informal economy represent bottlenecks to growth… In 2010, 59.3% of the labour force in Morelos attained below upper secondary education. Although this level is slightly below the Mexican average of 60.7%, it is considerably higher than the OECD average, 28.3%. Low levels of education can be a drag on labour productivity and the capacity to adapt to new economic conditions. Moreover, in a country such as Mexico, low education increases the likelihood of people being employed as informal workers. The state of Morelos is characterised by a large share of informality which reached 66.5% in 2014. This represents a bottleneck to growth as firms tend to remain small in order to avoid paying taxes and complying with labour regulations, furthermore small size reduces incentives to invest in and adopt new productive technologies. Informality is also a symptom of structural problems in the economy, such as the presence of weak public institutions, corruption, difficult access to credit, and a low educated workforce. Informality represents both a bottleneck for development to be tackled swiftly and effectively, and a signal of deeper (structural) problems. …as well as a business environment restricted by high-levels of insecurity and difficulty of enforcing contracts According to the “ease of doing business” indicator of the World Bank, Morelos ranks among the bottom performers in Mexico. In 2014, the World Bank’s indicator shows that in Cuernavaca (the capital of Morelos) businesses finds it particularly difficult to enforce contracts and deal with construction permits. Furthermore, Morelos has a negative record on security, which undermines the overall business environment. While improvements in security have been noted, Morelos still shows a much higher crime rate than the national Mexican average. In 2015, the state registered 25.78 intentional homicides per hundred thousand inhabitants, compared to a national average rate of 14.06. Although crimes tend to be concentrated in the main metropolitan areas, the whole region is affected by this negative trend. For instance, the tourism sector and related services like restaurants have been severely affected. 3. Policy responses should activate untapped sources of growth Improve the quality of basic education and training with particular attention to peripheral areas While the state of Morelos shows above national average performance levels in basic education, the overall quality of education is low compared to OECD peers. The programme for international student assessment (PISA) provides a benchmark to compare the performance of 15 year old students in Mexico (including Morelos) with students of a similar age in other OECD countries. In Morelos, low performing schools tend to be located in municipalities at the periphery of metropolitan areas and in lagging rural areas. In 2014, the drop-out rate in upper secondary education was 20.3% in Morelos, compared to a Mexican average of 13.1%, which placed Morelos at the bottom of national rankings in this dimension. Improvements were noted in 2015 as drop-outs reduced to 14.4% OECD TERRITORIAL REVIEWS: MORELOS, MEXICO © OECD 2017 20 – ASSESSMENT AND RECOMMENDATIONS (against 12.4% nationally) and preliminary data for 2016 shows further progress with below national average figures. To address the challenge of early school drop-outs, the state of Morelos created the Beca Salario pilot universal scholarship programme, implemented since 2013/14, to provide financial support to students to stay in education until the completion of undergraduate studies. Young graduates tend to lack the technical skills and knowledge expected in their respective fields of studies. According to surveys conducted among employers, 26% reported that they could not find a suitable candidate for their vacancies despite receiving applications for the post. This skill mismatch raises questions about the relevance of current education programmes for the local labour market. In the state of Morelos, as in all Mexican states, vocational programmes can represent tools to improve the alignment of skills supply with skills demand. However, the technical vocational education and training (TVET) system is quite complex and not always in line with the rapidly changing business environment.