Mexico - Knowledge and Innovation Project

Document of The World Bank Report No: 17896 PROJECT APPRAISAL DOCUMENT O NA PROPOSED LOAN IN THE AMOUNT OF US$300 MILLION TO MEXICO FORA KNOWLEDGE AND INNOVATION PROJECT May 22, 1998 Finance, Infrastructure and Private Sector Management Unit Mexico Country Management Unit Latin America and the Caribbean Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective May 15, 1998) Currency Unit = Mex$ Mex$8.51 = US$1 FISCAL YEAR July 1 - June 30 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy CCC President's Science Advisory Council - Consejo Consultivo de Ciencias CONACYT National Science and Technology Council - Consejo Nacional de Ciencia y Tecnologia DO Development Objective ESW Economic and Sector Work FIDETEC Research and Development Fund for Technological Modernization - Fondo de Investigacion y Desarrollo para la Modernizaci6n Tecnol6gica FORCCYTEC Fund for Scientific and Technological Capacity Strengthening - Fondo para el Fortalecimiento de las Capacidades Cientiflcas y Tecnol6gicas FSD Financial Sector Development Department FY Fiscal Year GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IDA International Development Association IADB Inter-American Development Bank INEGI National Institute of Statistics, Geography, and Informatics - Instituto Nacional de Estadistica, Geografia e Informatica IP Implementation Progress KIP Knowledge and Innovation Project LIBOR London Interbank Offer Rate MSTQ Metrology, Standards, Testing and Quality NAFIN Nacional Financiera, S.N.C. NAFTA North American Free Trade Agreement NIST National Institute of Standards and Technology NSF National Science Foundation OECD Organization for Economic Cooperation and Development PACIME Support Program for Science in Mexico - Programa de Apoyo a la Ciencia en Me'xico Vice President: Shahid Javed Burki Country Management Unit Director: Olivier Lafourcade Sector Management Unit Director: Krishna Challa, Acting Task Team Leader: Daniel Crisafulli  PAHO Pan American Health Organization PCD Project Concept Document PROMTEC Technology Modernization Support Program - Programa de Apoyo a la Modernizaci6n Tecnol6gica R&D Research and Development RFP Request for Proposals S&T Science and Technology SECOFI Ministry of Commerce and Industrial Development - Secretaria de Comercio y Fomento Industrial SECODAM Ministry of the Comptroller General SEP Ministry of Education - Secretaria de Educaci6n Pziblica SME Small and Medium Enterprise SHCP Ministry of Finance and Public Credit - Secretaria de Hacienda y Credito Puiblico SNI National System of Researchers - Sistema Nacional de Investigadores TBD To be determined UAM Autonomous Metropolitan University - UniversidadAut6noma Metropolitana UNAM National Autonomous University of Mexico - Universidad Nacional Aut6noma de Mexico WB The World Bank WHO World Health Organization  Mexico Knowledge and Innovation Project CONTENTS Pages A. Project Development Objective ...............2.......................................2 1. Project development objective and key performance indicators ............ ..........2 B. Strategic Context .......................................................2 1. Sector-related CAS goal supported by the project ...........................................2 2. Main sector issues and Government strategy ...................................................3 3. Sector issues to be addressed by the project and strategic choices ...................6 C. Project Description Summary ......................................................8 1. Project components .................................................8 2. Key policy and institutional reforms supported by the project ........................9 3. Benefits and target population ................................................ 10 4. Institutional and implementation arrangements ........................................... 11 D. Project Rationale ...................................................... 11 1. Project alternatives considered and reasons for rejection ............................... 11 2. Major related projects financed by the Bank and/or other development agencies ...................................................... 12 3. Lessons learned and reflected in proposed project design .............................. 13 4. Indications of borrower commitment and ownership .................... ................ 14 5. Value added of Bank support in this project ................................................... 14 E. Summary Project Analyses ...................................................... 14 1. Economic ...................................................... 14 2. Financial ...................................................... 14 3. Technical ...................................................... 15 4. Institutional ...................................................... 15 5. Social ...................................................... 15 6. Environmental assessment ...................................................... 15 7. Participatory approach ...................................................... 15  F. Sustainability and Risks ............................. 16 1. Sustainability ....................... 16 2. Critical risks ....................... 16 3. Possible controversial aspects ....................... 17 G. Main Loan Conditions ............................. 17 1. Disbursement and other conditions H. Readiness for Implementation ............................. 18 I. Compliance with Bank Policies ............................. 18 Annexes Annex 1. Project Design Summary .19 Annex 2. Detailed Project Description .22 Annex 3. Estimated Project Costs .31 Annex 4. Economic Analysis .32 Annex 5. Financial Summary .46 Annex 6. Procurement and Disbursement Arrangements .47 Table A. Project Costs by Procurement Arrangements .50 Table B. Thresholds for Procurement Methods and Prior Review .51 Table C. Allocation of Loan Proceeds .52 Annex 7. Project Processing Budget and Schedule .53 Annex 8. Documents in Project File .54 Annex 9. Statement of Loans and Credits. 5 5 Annex 10. Country at a Glance .57 Map  Mexico Knowledge and Innovation Project Project Appraisal Document Latin America and the Caribbean Regional Office Mexico Country Management Unit Date: May 22, 1998 Task Team Leader: Daniel Crisafulli Country Management Unit Director: Olivier Lafourcade Sector Management Unit Director: Krishna Challa, Acting Project ID: MX-PE-44531 Sector: Industry - Other (IY) Program Objective Category: Private Sector Development Lending Instrument: Specific Investment Loan Program of Targeted Intervention: [ ] Yes [X] No Project Financing Data [X] Loan [] Credit [] Guarantee [] Other [Specifyl For Loans/Credits/Others: Amount (US$m): 300.0 Proposed terms: [] Multicurrency [X] Single currency, specify: US Dollar Grace period (years): 3 [] Standard Variable [X] Fixed [] LIBOR-based Years to maturity: Standard for medium-disbursing loans Commitment fee: 0.75% less applicable waivers Financing plan (US$m): Source Local Foreign Total Government 209.3 0.0 209.3 IBRD 4.0 296.0 300.0 Private Sector 153.5 0.0 153.5 Total 366.8 296.0 662.8 Borrower: Nacional Financiera, S.N.C. Guarantor: United Mexican States Responsible agency: CONACY T Estimated disbursements (Bank FY/US$M): 1998 1999 2000 2001 2002 2003 Annual 6.0 26.0 60.0 68.0 70.0 70.0 Cumulative 6.0 32.0 92.0 160.0 230.0 300.0 Project implementation period: 5 years Expected effectiveness date: September 15, 1998 Expected closing date: December 31, 2003 OSD PAD Form: July 30, 1997  A: Project Development Objective 1. Project development objective and key performance indicators (see Annex 1): The Project aims to promote the generation, diffusion, and application of knowledge for innovation in support of economic and social development. Emphasis would be placed on stimulation of linkages and effective diffusion of knowledge for innovation, via the following actions: * Support excellence in science and technological research, increase the availability of scientific and technological human capital, and institute an integrated strategy for development of fields of science of strategic importance to Mexico's economic and social development. * Support increased firm-level productivity through provision of decentralized, demand-driven technological services for small and medium enterprises and creation of a pilot private sector-led venture capital scheme. * Facilitate linkages between private firms, universities and research institutions through financial support for joint activity and technical assistance to bridge institutions. B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1): CAS document: 16135-ME; Progress Report R98-49. Date of latest CAS discussion: March 26, 1998 The project would aim to support the CAS objective of Growth with Stability via actions to increase firm-level productivity in Mexico over the medium- and long-term. The CAS Progress Report states the problem clearly: "Productivity collapsed with the crisis in 1982 and it failed to grow significantly since.... Output per worker for the economy as a whole declined by 22 percent between 1981 and 1994 (Progress Report, p. 5)." In order for Mexico to achieve higher growth in total factor productivity (TFP) and thereby sustained growth in income and real wages, firms must improve levels of quality and technology. The potential impact of increased amount and effectiveness of investment in science and technology is illustrated by the maquila (in bond processing) sector. For Mexico as a whole, the average value added in the maquila sector is 3-5 percent. However, in areas with strong private sector-oriented universities and technological support services, such as Monterrey, the value added among maquiladoras exceeds 20 percent. Survey data indicate that the technical capacity of local firms plays a large role in determining export linkages. Increasing the performance of the system for knowledge and innovation throughout Mexico could therefore result in large gains in productivity and quality. The project would aim to strengthen firm-level capacity over the medium- to long-term via the restructuring of the system for knowledge and innovation - the set of institutions responsible for generation, diffusion and application of knowledge for productive purposes. Each component of the project would also support the objective of Modernization of the State. The project would streamline CONACYT administration overall in support of the CAS aim to "increase the effectiveness of public programs, e.g., improving efficiency and transparency." (CAS, p.7). The restructuring of most of the SEP-CONACYT system of science and technology centers would increase cost recovery while improving client orientation and effectiveness of service provision in support of industry. The firm-level technology enhancement component would be executed via a decentralized network of private agents. The project would also support the CAS objective of Social Development through increased educational opportunities in both public and private universities. Social benefits may also accrue from development of health sciences, biotechnology, and environmentally-friendly technologies. The Field Development sub-component would channel resources to emerging and lagging areas of science with important social impact. 2  2. Main sector issues and Government strategy: Poor Performance of System for Knowledge and Innovation. The Mexican innovation "system", comprised of the enterprises, universities, and other public and private institutions involved in the generation, diffusion, and application of knowledge for productive purposes, remains inefficient in channeling science and technology (S&T) investment into productive applications. Under the protection of a closed economy prior to 1986, Mexican industry developed in an environment in which enhancements in quality and technology were largely unrewarded. Even large firms apparently invest low amounts in adapting and developing new technologies: an estimated 66 percent of research and development (R&D) is financed by the government1, and fewer than 10 percent of researchers are employed by the private sector.2 Similarly, the academic and public iresearch sectors developed largely in isolation from the needs of industry. A 1997 evaluation of the PACIME project by international experts found "the scarce connection with productive sector or societal needs to be a matter of serious concern," and private sector use of the research infrastructure available at universities and technological institutes to be insignificant.3 Furthermore, institutions which could serve as bridges between universities and firms, including the system of SEP-CONACYT science and technology centers, have operated as academic research centers (in accordance with original objectives) rather than firm-oriented service organizations. Other bridge institutions have been slow to develop. Since the advent of economic liberalization, enterprises and researchers across Mexico have begun to work together on problems of industrial importance. However, Government policy and institutional framework do not yet provide support to these incipient joint initiatives. One result is that university-based researchers perform only 1.4 percent of R&D funded by the business enterprise sector (second lowest percent among OECD members).4 Low Public and Private Investment in Science and Technology. In addition to the low effectiveness of spending on science and technology, overall S&T investment levels remain low. Although small, open economies (even the most advanced) rely primarily on imported sources of technology, substantial investment in local human resources and infrastructure is required to ensure the absorption, adaptation and application of world-class technology. The percentage of GDP spent on R&D, for example, is the lowest in the OECD (0.31 percent for Mexico versus 0.38 percent for Turkey), and about one seventh of the OECD average.5 This figure is also less than half of that spent by non-OECD comparator countries, such as China (0.7 percent), and India (0.8 percent). Mexico has the lowest concentration of researchers per population of OECD members, with only 6 researchers per 1 0,000 inhabitants vs 48 in Korea and 29 in Poland6, and compares adversely with other developing countries such as India (4.8).7 Low productivity growthi/investment in firm upgrading Despite more than a decade of structural reform, productivity growth among Mexican firms has continued to lag. Total factor productivity in industry grew by only 0.9 percent during 1988-94; performance in the manufacturing sector was more positive at 2.4 percent for the same period.8 '1995 data. Source: CONACYT. 2 Indicadores de Actividades Cientificas y Tecnol6gicas, CONACYT, 1995. 1997 Evaluations of PACIME by J.M. Rojo, Universidad Complutense de Madrid, A. Kuppermann, CalTech, and D. Newlon, NSF. University Research in Transition, OECD: Paris, 1998. 1995 data, source: OECD MSTI Database, November 1997. 6 Ibid. 1992 data cited in Science & Engineering Indicators, National Science Foundation, National Science Board, 1996. 8 Barry Bosworth, 1997, cited in Mexico: Enhancing Factor Productivity Growth. Country Economic Memorandum, World Bank, draft, 1998. 3  Furthermore, productivity gains have apparently been concentrated among large firms, which have been far more successful in acquiring and applying new technologies than small and medium enterprises (SMEs). As a result, large firms have successfully linked with international markets for both goods and services (including financial markets). Notably, large Mexican firms maintained access to international financial markets even during the crisis of 1994-51, an indicator of their ability to achieve a certain level of quality and technology. In comparison to large firms, small and medium enterprises have faced significant barriers to increased productivity and quality. Lack of linkage to international and local sources of technology has inhibited upgrading of capacity. Furthermore, investment in SMEs has been limited largely to family resources - particularly in the wake of the 1994-5 financial crisis. Causality is difficult to establish, but survey data indicate that low investment in technology among SMEs is driven by low managerial administrative capacity and awareness of available alternatives rather than simply a lack of access to capital.2 In addition, data suggest that relatively small investments in external advisory services and equipment could have a large impact on productivity among SMEs. Lack of demand-driven technological support institutions Mexican policy to support firm-level technological enhancement has been reduced in effectiveness due to a variety of factors, including: a narrow definition of individual program objectives; inadequate integration of support services provided by various public and private agencies; a tendency toward centralized control by federal agencies; and an over-emphasis on creation of the supply of services versus incentives for articulation of demand. The CIMO program (Programa de Calidad Integral y Modernizacion - Program for Integral Quality and Modernization), established under the Mexico Labor Market and Productivity Enhancement Project, Loan 3542-ME and administered by the Labor Ministry, has provided the largest window of support for firm-level technology modernization to date. This decentralized, locally-managed program provides firm-level training for upgrading administration, quality, and productivity in addition to traditional worker technical training. Subject to an in-depth evaluation in 1995, this ongoing program channeled resources to over 30,000 firms and trained over 200,000 workers during 1988-92. The program remains limited, however, in the extent to which technological upgrading may be supported. Consultancies are limited to approximately US$2,000 per participating firm, well below levels needed for any work beyond an initial diagnostic. Low effectiveness of research programs The effectiveness of Mexican investment in science and technology research may be viewed as a function of productivity of researchers (in terms of publications, training of human resources) and relevance of output to social and economic development. Regarding the first factor, significant improvement in productivity of Mexican research has occurred in recent years, as evidenced by the 9.6 percent per annum increase in scientific and technological publications in refereed international journals during 1990-95.3 Despite this impressive growth, productivity remains low in international terms at 0.42 publications per researcherper annum.4 Human resource formation, a critical output of research projects, also remains disappointingly low. Mexico trains fewer Ph.D.s per year than comparator countries, granting about 3 Ph.D.s annually in science and engineering per million inhabitants compared to 5 in India, 6 in Brazil, ' Mexico: Financing the Real Sector, World Bank, draft, 1998. 2 Competitividad de la Industria Manufacturera de la Zona Metropolitana de la Ciudad de Mexico: Indicadores de Calidad y Productividad 1995, CONACYT, 1996. ISI Science Citation Index, cited in Indicadores de Actividades Cientificas y Tecnologicas, CONACYT, 1997. Average publications for SNI members during 1993-95, Indicadores de Actividades Cientificas y Tecnol6gicas, CONACYT, 1997. 4  and 19 in Korea per million inhabitants.1 The second determiner of effectiveness, relevance, also remains at apparently low levels. Although more difficult to measure than traditional academic output, available data on placement of students in industry and patents indicate a low level of linkage between academia and industry. Fluctuation of Support to Research Programs Fluctuation in support to scientific and technological research project has been severe, often increasing or decreasing by as much as 50 percent annually over the past 25 years2: Annual Fluctuation in Funding LeveIsfor CONACYT Research Projects 1973-94 (in constant pesos) 100 i 0 - - -- - -" r , - - E-20 en 0X