EL SALVADOR: POLICIES FOR BUSINESS RECOVERY, JOBS AND ECONOMIC TRANSFORMATION June 2021 © 2021 The World Bank Group 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org SOME RIGHTS RESERVED This work is a product of the staff of The World Bank Group with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank’s Board of Executive Directors, or the governments they represent. The World Bank Group does not guarantee the accuracy of the information included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank Group concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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El Salvador: Policies for Business Recovery, Jobs and Economic Transformation. © World Bank Group.� All queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org. -i- Table of Contents ACRONYMS...................................................................................................................................... VI ACKNOWLEDGEMENTS .................................................................................................................... IX EXECUTIVE SUMMARY .......................................................................................................................1 1. OVERVIEW AND INTRODUCTION .................................................................................................4 1.1. Overview of priority areas ............................................................................................................ 7 1.2. COVID-19 impacts on firms and policy responses ...................................................................... 10 2. BUSINESS REGULATORY ENVIRONMENT.................................................................................... 14 2.1. Regulatory governance and predictability in implementing laws and regulations .................... 19 2.2. Digital Readiness ......................................................................................................................... 24 2.3. Cost of doing business in the formal sector................................................................................ 28 2.4. Trade facilitation ......................................................................................................................... 35 2.5. Property rights, institutional quality and contractual environment........................................... 39 2.6. Suggested Business Regulatory Environment Action Plan ......................................................... 41 3. FOREIGN DIRECT INVESTMENT .................................................................................................. 49 3.1. FDI performance ......................................................................................................................... 49 3.2. Main FDI attraction challenges ................................................................................................... 53 3.3. Potential reform areas ................................................................................................................ 56 3.4. FDI Action Plan ............................................................................................................................ 71 4. ACCESS TO PRODUCTIVE FINANCE ............................................................................................. 73 4.1. The financial sector in El Salvador: structure and performance ................................................. 74 4.2. Access to productive finance in El Salvador................................................................................ 77 4.3. National Financial Inclusion Policy .............................................................................................. 81 4.4. The role of the state in the provision of finance: the visible hand ............................................. 84 4.5. Development banks, public banks and public financial instruments in El Salvador ................... 86 4.6. Suggested Access to Productive Finance Action Plan ................................................................. 87 5. INNOVATION AND ENTREPRENEURSHIP .................................................................................... 89 5.1. Entrepreneurship ecosystem conceptual framework ................................................................ 90 5.2. Entrepreneurship and innovation in El Salvador ........................................................................ 92 5.3. Local entrepreneurship ecosystems in El Salvador..................................................................... 99 5.4. Entrepreneurship and innovation policies ................................................................................ 103 5.5. Suggested Innovation and Entrepreneurship Action Plan ........................................................ 117 6. PARTICIPATION IN GLOBAL VALUE CHAINS .............................................................................. 124 6.1. GVCs for jobs and economic transformation ............................................................................ 125 6.2. COVID-19 pandemic implications for GVCs .............................................................................. 128 6.3. Current GVC participation and performance in El Salvador ..................................................... 130 6.4. Participation of El Salvador in selected GVCs ........................................................................... 133 - ii - 6.5. Main challenges and reform areas ........................................................................................... 143 6.6. Suggested GVCs Action Plan ..................................................................................................... 146 ANNEX 1: FULL LIST OF GROWTH, JOBS, AND MSME SUBJECTS AND REPORT COVERAGE ................. 149 ANNEX 2: WBG JOBS AND ECONOMIC TRANSFORMATION FRAMEWORK ........................................ 150 ANNEX 3: WORLD BANK COVID-19 EL SALVADOR ENTERPRISE SURVEY RESULTS .............................. 151 ANNEX 4: FDI COMPARATOR PEERS’ SELECTION ............................................................................. 153 ANNEX 5: INNOVATION AND ENTREPRENEURSHIP .......................................................................... 154 REFERENCES .................................................................................................................................. 156 List of Figures Figure 1: GDP per capita, 2000-2019 ............................................................................................................ 4 Figure 2: Real GDP growth and contributions, percentage points ............................................................... 5 Figure 3: Types of COVID-19 support requested by firms .......................................................................... 13 Figure 4: Perception of the investment climate in El Salvador, 2008-2019 ............................................... 14 Figure 5: El Salvador’s performance on GCI 2019 and DB 2020 ................................................................. 16 Figure 6: New businesses entry rate in El Salvador and Central America .................................................. 16 Figure 7: El Salvador lags behind most Latin American countries when it comes to e-government ......... 18 Figure 8: WGI’s Government effectiveness scores for 2018 and its evolution in time in CA ..................... 19 Figure 9: Stakeholder engagement in developing subordinate regulations for selected LAC countries (OECD iREG for 2015 and 2019) ............................................................................................................................. 21 Figure 10: Level of government at which administrative simplification processes have taken place in LAC countries ..................................................................................................................................................... 22 Figure 11: Cost and paid-in minimum capital requirement to open a business in Central America .......... 29 Figure 12: Doing Business’ performance and cost of construction permits in Central America ................ 32 Figure 13: Access to electricity connections (left axis) and percent of firms identifying electricity as a main obstacle in El Salvador (right axis) .............................................................................................................. 34 Figure 14: Judicial system efficiency measured by different benchmarks for Central America ................. 40 Figure 15: Quality of Land Administration in Central America (DB 2020) .................................................. 41 Figure 16: Foreign Direct Investment, net inflows, BoP current US$millions (2000 – 2019) ..................... 50 Figure 17: Foreign Direct Investment, net inflows, percent of GDP (2000 – 2019).................................... 50 Figure 18: FDI source countries’ dependency vs peer countries (2017) .................................................... 51 Figure 19: Top five source countries of FDI by FDI inward stock, (2017) ................................................... 51 Figure 20: New FDI projects ("Greenfield Projects") in El Salvador (2003-2021), by sectors ..................... 51 Figure 21: El Salvador’s Detailed Greenfield FDI Announcements, (2002-2021), by economic activity .... 51 Figure 22: FDI typologies and relevance for growth/job creation .............................................................. 52 Figure 23: Exports of FDI firms in El Salvador (2005-2017) ........................................................................ 52 Figure 24: Share of El Salvador´s greenfield FDI by type (2002-2016)........................................................ 53 Figure 25: Share of El Salvador´s greenfield FDI by type and sector (2002-2016)...................................... 53 Figure 26: Investment Facilitation Index, El Salvador and regional peer countries 0-2 (best), (2020)....... 54 Figure 27: FDI regulatory index panel, 0-100 (worst), (2017) ..................................................................... 54 - iii - Figure 28: Business impact of rules on FDI 1-7 (best), (2017) .................................................................... 54 Figure 29: Strength of investor protection 0-10 (best), (2017) .................................................................. 55 Figure 30: FDI and technology transfer 1-7 (best), (2017).......................................................................... 55 Figure 31: Buyer sophistication 1-7 (best), (2017)...................................................................................... 55 Figure 32: Local supplier quality 1-7 (best), (2017) .................................................................................... 56 Figure 33: Local supplier quantity 1-7 (best), (2017) .................................................................................. 56 Figure 34: The WBG institutional framework for Investment Policy and Promotion ................................. 59 Figure 35: Comprehensive Investor Services Matrix ................................................................................. 62 Figure 36: Good practices for the design of investment incentives ........................................................... 66 Figure 37: Private Credit to GDP in El Salvador .......................................................................................... 74 Figure 38: Selected 2017 Global Findex Indicators of Financial Access ...................................................... 78 Figure 39: Indicators of Financial Access for Firms ..................................................................................... 80 Figure 40: NFIP Policy Areas........................................................................................................................ 82 Figure 41. Entrepreneurial ecosystem framework ..................................................................................... 91 Figure 42. Registration of new businesses and GPD per capita, 2018........................................................ 92 Figure 43. Share of young formal firms (0-3 years in operation), 2016 ..................................................... 92 Figure 44. Employment growth in formal firms (%), 2016 ......................................................................... 92 Figure 45. Average size of formal firms with more than 20 years in operation (# of workers), 2016........ 92 Figure 46. Share of entrepreneurs with employees, 2016 ......................................................................... 92 Figure 47. Global Innovation Index Ranking, 2020 ..................................................................................... 93 Figure 48. Global Innovation Index and GDP per capita, 2020* ................................................................. 93 Figure 49. Percentage of firms that introduced innovations ...................................................................... 94 Figure 50. Percentage of firms investing in R&D ........................................................................................ 94 Figure 51. GDP share of R&D investment ................................................................................................... 94 Figure 52. Percentage of high-tech manufacturing exports ....................................................................... 94 Figure 53. Percentage of tertiary and sciences and engineering graduates .............................................. 95 Figure 54. Number of researchers per million people ................................................................................ 95 Figure 55. Percentage of population using Internet ................................................................................... 95 Figure 56. Percentage of firms exporting directly or indirectly at least 10 percent of sales ...................... 96 Figure 57. Percent of manufacturing firms using material inputs and/or supplies of foreign origin ......... 96 Figure 58. Percentage of firms internationally certified ............................................................................. 96 Figure 59. Percentage of firms with official websites ................................................................................. 96 Figure 60. Percentage of adults who fear of failure would prevent them from starting a business.......... 97 Figure 61. Percentage of adults who believe they have the required skills and knowledge to start a business .................................................................................................................................................................... 97 Figure 62. Motivational index (improvement-driven opportunity entrepreneurs versus those motivated by necessity)................................................................................................................................................ 97 Figure 63. Percentage of adults who believe that entrepreneurship is a good career choice ................... 98 Figure 64. Percentage of adults who personally know entrepreneurs....................................................... 98 Figure 65. Ratio of female to male entrepreneurship ................................................................................ 98 Figure 66. Percentage of firms with a female top manager ....................................................................... 98 Figure 67. Entrepreneurships ecosystems in El Salvador ......................................................................... 101 Figure 68. Main expected outcomes of government programs ............................................................... 105 Figure 69. Mechanisms of intervention by public programs .................................................................... 107 - iv - Figure 70. Number of beneficiaries by program ....................................................................................... 109 Figure 71. Average budget per beneficiary by program ........................................................................... 110 Figure 72: What it is a GVC?...................................................................................................................... 125 Figure 73: GVCs and growth, productivity and jobs ................................................................................. 126 Figure 74: National policies can enhance the benefits of participation in GVCs ...................................... 128 Figure 75: El Salvador’s Export Revealed Comparative Advantage and China’s Export Share to the US and the World .................................................................................................................................................. 129 Figure 76: Export Basket Composition 2000 and 2018 ............................................................................. 131 Figure 77: Exports by Partner ................................................................................................................... 132 Figure 78: Exports and job creation .......................................................................................................... 132 Figure 79: BPO services exports - top 10 Spanish-speaking countries (USD million) ............................... 142 List of Tables Table 1: COVID-19 economic shocks........................................................................................................... 10 Table 2: Sectors in El Salvador exposed to shutdown and demand shocks ............................................... 11 Table 3: COVID-19 impacts on firms and policy responses ........................................................................ 12 Table 4: El Salvador’s performance on international benchmarks related to ICT adoption and digital practices ...................................................................................................................................................... 26 Table 5: Various municipal fees related to construction permits in four Salvadorian cities ...................... 33 Table 6: Available Financial Products and Services in El Salvador .............................................................. 77 Table 7. Characteristics of businesses in the data .................................................................................... 100 Table 8: Summary of maturing and high potential ecosystems across industries ................................... 103 Table 9: Main entrepreneurship services provided by government support programs, based on 2019 surveys ...................................................................................................................................................... 113 Table 10. Programs, funds, and competitions to support entrepreneurship and innovation of MINEC /FONDEPRO 2020-2021 ............................................................................................................................ 114 Table 11: Main entrepreneurship services provided by supporting organizations .................................. 116 Table 12: Key value chains ........................................................................................................................ 134 Table 13: Characteristics of businesses in the database of El Salvador.................................................... 154 Table 14: Characteristics of ecosystems in El Salvador............................................................................. 155 -v- Acronyms AFI Alliance for Financial Inclusion ANDA National Administration for Aqueducts and Sewer ASOMI Association of Microfinance Institutions B2C Business-to-Consumer BANDESAL Development Bank of the Republic of El Salvador (Banco de Desarrollo de la Republica del Salvador) BCR Central Reserve Bank BFA Banco de Fomento Agropecuario BH Banco Hipotecario BMI Banco Multisectorial de Inversiones BPO Business Process Outsourcing CA Central America CAMARASAL Cámara de Comercio e Industria de El Salvador CATIS Technology and Innovation Support Centers CDMYPE Centers for Micro and Small Enterprises CIEX/BCR Center for Import and Export Procedures run by the Central Bank CNIEF Consejo Nacional de Inclusión y Educación Financiera CNJ National Centre of the Judicature CNR National Centre of Registries COFEMER Federal Regulatory Improvement Commission (Mexico) CONACYT National Council for Science and Technology CONAMER National Commission for Regulatory Improvement (Mexico) CONAMYPE National Commission of Micro and Small Enterprises CORSAIN Corporación Salvadoreña de Inversiones COVID-19 Coronavirus disease 2019 CPI Corruption Perception Index DAN Directorate of Antinarcotics DB Doing Business report DBs Development Banks DGA Customs Administration (Dirección General de Aduanas) eCommerce Electronic Commerce eGovernment Electronic Government EIR Regulatory Impact Assessment ES Enterprise Survey eSignature Electronic Signature FDE Fondo de Desarrollo Económico FDI Foreign direct investment FOCOOP Salvadoran Institute for Cooperative Development FONAVIPO Fondo Nacional de Vivienda Popular FONDEPRO Fund of Productive Development FSG Fondo Salvadoreño de Garantías FSV Fondo Social para la Vivienda FUSADES Salvadorian Foundation for Economic and Social Development G2B Government-to-Business G2C Government-to-Consumer - vi - GATIF Grupo de Apoyo en Temas de Inclusión Financiera GCI Global Competitiveness Index GDP Gross Domestic Product GEI Global Entrepreneurship Index GGSS Global Startup Survey GII Global Innovation Index GVC Global value chain IAIP Access to Public Information Agency ICT Information and Communication Technologies IEF Index of Economic Freedom IEP Institute for Economics and Peace IFC International Finance Corporation IGD Deposit Guarantee Institute INPEP National Pensions Institute for Public Employees iREG Indicators of Regulatory Policy and Governance ISSS Salvadorian Social Security Institute ITU International Telecommunications Union JET Jobs and Economic Transformation JOM Commercial Oral Proceedings Program (Mexico) LAC Latin America and the Caribbean LEAT Special Law on Agile Procedures to Incentivize Construction Projects LFSPD Law of the Financial System for the Promotion of Development Promotion LMC Lower middle-income countries LMR Law of Better Regulation LoCs Lines of credit LPA Law of Administrative Procedures M&E Monitoring and evaluation MAG Ministry of Agriculture and Livestock MARN Ministry of Environment and Natural Resources MINEC Ministry of Economy MINSAL Ministry of Health MoMo Mobile Money Centroamérica MoUs Memorandum of Understanding MSMEs Micro, Small and Medium Enterprises MT Medium-term MYPE Law Law for the Development, Promotion and Protection of Micro and Small Enterprises MYPEs Micro and Small Enterprises NBFIs Non-Bank Financial Intermediaries NBSCIs Non-Bank Savings and Credit Institutions NFIP National Financial Inclusion Policy NGOs Non-Governmental Organizations OECD Organisation for Economic Co-operation and Development OMR Regulatory Improvement Agency (Organismo de Mejora Regulatoria) OPAMSS Planning Office of the Metropolitan Area of San Salvador PNC El Salvador Police (Policia Nacional Civil) PROESA Exports and Investment Promotion Agency of El Salvador PROREFORMA Priority Sectors Reform Program (Mexico) - vii - PROSARE SARE’s quality certificate (Mexico) R&D Research and Development RI Regulatory Improvement RNT National Procedures Registry SACs Savings and Credit Companies SAIDI System Average Interruption Duration Index SAIFI System Average Interruption Frequency Index SARE System for Quick Business Start-Up (Mexico) SC Superintendencia de Competencia SETEPLAN Technical and Planning Secretariat SIAI Integral System for Investors Attention SIGET Superintendency of Electricity and Telecommunications SIMPLIFICA Administrative Simplification Program (Mexico) SLV El Salvador SME Small and Medium-sized Enterprises SOBS State-owned banking system SOFIs State-Owned Financial Institutions SSF Superintendence of the Financial System ST Short-term STI Science, Technology and Innovation TEBB Elimination of Bureaucratic Barriers Tribunal UNCTAD United Nations Conference on Trade and Development VECS Simplified Window for Construction Permits (Mexico) WB World Bank WBES World Bank Enterprise Survey WBG World Bank Group WDI World Development Indicators WEF World Economic Forum WGI Worldwide Governance Indicators (World Bank) WIPO World Intellectual Property Organization - viii - Acknowledgements The team would like to thank the Government of El Salvador for the guidance and information provided throughout the report preparation process. We would also like to thank the many private sector and civil society representatives who kindly shared their views on MSME, growth, and jobs challenges. The report was prepared by a team led by Thomas Haven. The core team included Sylvia Solf and Aldo Sanchez (business regulatory environment); Yago Aranda Larrey (FDI); Mónica Parra Torrado (innovation and entrepreneurship); Rafael Pardo (access to productive finance); and Alberto Criscuolo and Lucio Castro (GVCs). Important contributions were also made by Gabriela Montenegro (business regulatory environment, trade facilitation, innovation and entrepreneurship), Marcio Cruz (innovation and entrepreneurship), Jesica Torres Coronado (innovation and entrepreneurship), Mayra Alfaro de Morán (trade facilitation), Ernesto Martin-Montero (business regulatory environment), Alex Sanchiz Vicente (FDI), Sergio Pelaez Sierra (innovation), Daniel Stagno (revisions), Reyes Aterido (data analysis), Miguel Angel Jimenez Gallardo (data analysis), Jania Ibarra (El Salvador operations), Susana Hortencia Mendez Madrid (El Salvador support), and Monzerrat Garcia (Washington, DC support). Feedback was provided by peer reviewers Dusko Vasiljevic, Ivan Nimac, Jaime Frias, and Jose Ernesto Lopez Cordova. The report was prepared under the leadership and guidance of Seynabou Sakho, Zafer Mustafaoglu, Oscar Avalle, and Pedro Rodriguez. - ix - Executive Summary Executive Summary El Salvador’s low historic growth rate combined with the COVID-19 crisis present a dual challenge for economic development. Living standards will only be improved by creating more productive, formal private sector jobs. More attractive jobs paying higher wages means increasing productivity through economic transformation. However, El Salvador has not benefited from productivity growth and transformation in recent years, and the COVID-19 crisis has only intensified the urgency for reforms. The report identifies the need for reforms in five complementary areas to boost recovery, productivity, and economic transformation: 1) business regulatory environment; 2) foreign direct investment (FDI); 3) access to productive finance; 4) innovation and entrepreneurship; and 5) participation in global value chains. These areas were selected through consultations with the government and private sector and to complement other analytical work. This report analyzes each area in detail and suggests concrete reform action plans. A cross-cutting trend—which has been accelerated by the COVID-19 crisis —is the importance of digitization within both the public and private sectors. Public policies to support digitization can increase efficiency, enable new business models, and keep firms from lagging behind in domestic and global markets. A brief rationale and priority reforms for each area are outlined below. Reforms are categorized as: a) short-term priorities, including COVID crisis recovery reforms and low-hanging fruit; and b) structural reforms that are critical for El Salvador’s development in the medium-term. 1. Business regulatory environment Rationale • A healthy business environment promotes new firm entry, formalization, and expansion, as well as reallocations of capital and labor from firms that are no longer viable due to the COVID crisis to firms that can adapt. Short-term • Streamline key regulatory processes for business entry, operation, and exit, e.g. by adding priorities online processes and payments to MiEmpresa.gob.sv. • Implement the electronic signature and the e-Commerce Law. • Pass an insolvency law. • Simplify procedures for sanitary registration and import permits of controlled goods, following regional best practices. Structural • Implement the regulatory improvement agenda and its legal framework across all agencies reforms and levels (including municipal). • Implement the digital agenda to facilitate G2C, G2B, B2B, and B2C transactions (legal and regulatory foundation, processes, promotion, etc.). • Increase public consultations and private sector involvement in regulatory policy formulation and implementation. • Fully implement integrated risk management system for import/export; implement joint procedures with Guatemala and Honduras border control authorities. • Strengthen contract enforcement and promote alternative dispute resolution mechanisms. Responsible • Ministry of Economy, Regulatory Reform Agency (OMR), Customs Administration, National entities Directorate of Medicines, Ministry of Health, Ministry of the Environment, Ministry of Agriculture and Livestock, Secretaría de Innovación, municipal authorities, as well as the legislative and judicial branches, among other sectorial institutions. 1 Executive Summary 2. Foreign direct investment Rationale • Key source of jobs and catalyst for upgrading local production. Short-term • Improve the strategic framework for FDI attraction, including clear objectives, targets, priorities institutional roles, and priority sectors (taking into account the impacts of the COVID crisis on sector viability/ attractiveness). Assess the new InvestSV promotion strategy and its sectoral implications. • Design and implement an inter-institutional coordination mechanism for investment promotion • Increase capacity of the Exports and Investment Promotion Agency of El Salvador (PROESA) to provide key services to investors including aftercare and advocacy activities considering COVID-induced challenges) Structural • In alignment with currently implemented efforts, evaluate the effectiveness of existing reforms incentives via cost-benefit analyses and qualitative assessments. Redesign and/or replace with lower fiscal cost instruments if necessary (including non-fiscal incentives). • Develop a program to foster linkages between FDI and the local economy. Responsible • PROESA, Ministry of Economy, Secretariate of Trade and Investment, Ministry of Foreign entities Affairs 3. Access to productive finance Rationale • The financial sector intermediates resources for their optimal use, supplies the economy with necessary financial products that reduce costs, minimize risks, manage the impact of situations of crisis, increase capacity, and support the viability of firms. The financial sector is key to unlocking scarce financial resources during the pandemic. Short-term • Strengthen, capitalize and promote BANDESAL’s Fondo Salvadoreño de Garantías to mitigate priorities the increasing credit risk associated with the pandemic. • Design public sector programs, administered by State Owned Financial Institutions, to expand liquidity through the financial sector. • Promote digitalization of transactions to distribute government assistance programs (subsidies - G2P) and facilitate payments (and consequently increase financial access). Structural • Strengthen the Emergency Liquidity Assistance framework at Banco Central de Reserva. reforms • Implement the National Financial Inclusion Policy. Responsible • Banco Central de Reserva (BCR), Superintendencia del Sistema Financiero (SSF), Banco de entities Fomento Agropecuario (BFA), Banco Hipotecario (BH), BANDESAL, Fondo Salvadoreño de Garantías (FSG), CONAMYPE. 4. Innovation and entrepreneurship Rationale • Central to producing higher value-added products and services, which pay better wages and stimulate economic transformation. Also critical for firm adaptations to the COVID-19 crisis. Short-term • Implement large-scale business training to micro and small firms for crisis recovery, priorities adaptation, and digitization • Implement technology adoption / innovation grant program to help firms digitize and transform production, including to meet post-COVID demands Structural • Develop start-up grant program to help high-potential entrepreneurs take advantage of reforms post-COVID crisis opportunities • Study how to strengthen local high-potential entrepreneurship ecosystems, e.g. digital technologies in San Salvador, high-tech manufacturing in La Libertad, etc. • Strengthen linkages between firms and knowledge providers, e.g. through voucher program for firms to purchase knowledge services Responsible • Ministry of Economy, CONAMYPE, Secretaria de Innovación entities 2 Executive Summary 5. Global value chains Rationale • Strategic repositioning into higher-value segments of GVCs can create better jobs. The COVID- 19 crisis could also bring opportunities for repositioning. Short-term • Assign entity responsible for coordinating value chain development within the government priorities and with industry representatives • Identify and implement short-term measures to stimulate recovery of selected sectors. For example, for tourism: • Develop a “safe tourism� certification program and help tourist facilities get certified (in light of COVID-19) • Improve digitization and online presence of tourism businesses (given that travelers may require more information online, e.g. on health protocols, prior to a trip, as well as to conduct more transactions online prior to and during trips.) Structural • Identify / validate key interventions for medium-term strategic repositioning of selected reforms GVCs, including related to improving infrastructure, fostering human capital, enhancing the provision of sector-specific public goods, improving market access, and digitization • Coordinate with public and private stakeholders to implement selected interventions Responsible • Ministry of Economy, Ministry of Agriculture and Livestock, PROESA and others entities 3 Overview and Introduction 1. Overview and Introduction El Salvador’s low historic growth rate combined with the crisis caused by COVID-19 present a dual challenge for economic development. El Salvador needs to boost economic growth if it is to achieve standards of living found in some neighboring countries. Growth has been stable but low in recent years, averaging 1.8 percent annually between 2014–2018. This growth rate would have to at least double if El Salvador hopes to approach average income per capital levels in Latin America (Figure 1).1 On top of El Salvador’s historical growth challenges, the COVID-19 crisis has had a devastating effect on the economy. Recent estimates from the World Bank's "Global Economic Prospects" report show El Salvador's GDP declining by 7.2 percent during 2020, although the report projects a significant recovery of the Salvadoran economy in 2021 (estimated GDP growth of 4.6 percent).2 Figure 1: GDP per capita, 2000-2019 12,000 10,000 GDP per capita (current US$) 8,000 6,000 4,000 2,000 - 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 LAC SLV CA Note: LAC = Latin America and Caribbean average; CA = Central America average (excluding El Salvador); SLV = El Salvador Source: World Bank, World Development Indicators Living standards will only be improved by creating more productive, formal private sector jobs. About 70 percent of workers are informal and only about 60 percent of the working age population is employed. Employment rates are even lower for women and youth (47 percent for both).3 For workers to be enticed out of inactivity and the informal sector, more attractive jobs are needed. More attractive jobs paying higher wages means increasing productivity through economic transformation. El Salvador has not benefited from productivity growth and economic transformation in recent years. The contribution of total factor productivity (TFP) to El Salvador’s GDP growth has been negative over the last two decades (Figure 2). Although El Salvador’s total exports have grown substantially, the composition of exports has been largely similar over the same period, with a predominance of textiles and 1 Assumes that LAC average GDP per capita growth rates follow a historic trend of about 1.5 percent annually. 2 World Bank Global Economic Prospects, January, 2021. https://www.worldbank.org/en/publication/global-economic-prospects 3 World Bank (2020c), El Salvador Jobs Diagnostic, based on 2017 household survey (EHPM). 4 Overview and Introduction other low value-added products. (See Figure 48, which compares El Salvador’s export basket composition in 2000 and 2017.) Given the relatively small size of El Salvador’s economy, economic transformation based on a more sophisticated and dynamic export sector will be critical. Figure 2: Real GDP growth and contributions, percentage points Source: World Bank (2020d), Unleashing Central America’s Growth Potential, using Penn World Tables 9.1. The Government of El Salvador requested support from the World Bank to address its economic development challenges. This initially came in the form of inputs to the government’s Plan de Despegue Económico in early 2020. Consultations with the government and private sector highlighted the following priority areas for in-depth analysis and recommendations: • Business regulatory environment • Foreign direct investment (FDI) • Access to productive finance • Innovation and entrepreneurship • Participation in global value chains (GVCs) These five areas are the focus of this report. These priority areas all play a vital role in boosting productivity and economic transformation. There are three main ways to boost the productivity of an economy: a. Create new dynamic and innovative firms, with higher than average productivity b. Increase the productivity of existing firms c. Shift workers from less productive to more productive firms and sectors The priority areas address all of these productivity drivers. For instance, a friendly business environment facilitates the opening of new firms, as well as the closure of uncompetitive firms and the reallocation of labor between them. It also incentivizes productivity-enhancing competition by creating a transparent and level playing field. FDI can bring foreign firms that are more productive and can transfer technology to local firms. Access to productive finance is critical for new and existing firms to make productivity- 5 Overview and Introduction enhancing investments. Innovation and entrepreneurship are fundamental to the creation of dynamic startups and new and better products and processes within firms. Upgrading participation in global value chains entails adopting more productive technologies and producing higher value-added exports. The government of El Salvador has also prioritized the development of micro and small enterprises, given their vital role in the economy and social fabric.4 It is estimated that there are close to 318,000 micro and small firms in El Salvador. They represent approximately 35 percent of the country’s GDP and generate more than 850,000 jobs, the equivalent to close to one third of the economically active population.5 Micro and small firms also play a central role in promoting equity and inclusion. For example, close to 60 percent are owned by women. Besides smaller firms’ importance for jobs and inclusion, support is justified given the differential constraints they face compared to larger firms. With respect to the COVID-19 crisis, there is an emerging international consensus around the importance of helping medium firms survive, given their strong organizational capital and productive structures that would be hard to replace if lost. Research also suggests that firm age can be an important targeting criterion, given that job creation tends to be driven by a small set of young and fast-growing firms. Hence, the analysis in this report is geared micro, small, and medium enterprises (MSMEs), as well as younger firms. The COVID-19 crisis has intensified the urgency for reforms to support business recovery and sustainable growth. The identified priority areas are all highly relevant to the recovery, as the productivity drivers noted above have been accelerated by the crisis. Many businesses that are no longer viable will have to close and capital and labor must be reallocated to more productive firms, requiring a flexible and agile business environment. Access to productive finance will be critical to bridge liquidity shortages. And there will be opportunities for innovative entrepreneurs to adapt their business models and produce newly demanded products and services. The speed and magnitude of the impacts of the crisis on firms merit an equally aggressive policy response. An overview of COVID-19 transmission channels, impacts on firms, and high-level policy responses are discussed below. More detail on COVID-19 impacts and policy implications are also included in each of the chapters of the report. A cross-cutting theme is improving El Salvador’s institutional framework for policymaking related to jobs and economic transformation. This entails improving coordination within the public sector, including between the Ministry of Economy, Secretariat of Trade and Investment, Secretariat of Innovation, National Commission for Micro and Small Enterprises (CONAMYPE), Development Bank of the Republic of El Salvador (BANDESAL), Exports and Investment Promotion Agency (PROESA), and others. Also important is close coordination with the private sector through frequent formal and informal consultations. Better coordination can yield more integrated and coherent strategies that enjoy widespread support, maximize complementarities, and avoid overlaps. Systematic monitoring and evaluation should also be built in to policy design from the outset. There are other challenges to El Salvador’s economic recovery and development not covered by this report. Examples included crime and violence, political stability, physical infrastructure and 4 Legal and institutional mechanisms to promote micro and small firms include the Law for the Development, Promotion and Protection of Micro and Small Enterprises (MYPE Law, https://www.asamblea.gob.sv/decretos/details/1767) and the National Commission for Micro and Small Enterprises (CONAMYPE). 5 Based on: Micro and Small Enterprise National Survey 2017, DIGESTYC-CONAMYPE; National Policy for the Development of Micro and Small Businesses, MINEC & CONAMYPE; Multipurpose Household Survey (EHPM) 2018. 6 Overview and Introduction telecommunications, skills and labor market participation. Some of these are covered in complementary World Bank analyses, such as Unleashing Central America’s Growth Potential (forthcoming), El Salvador Jobs Diagnostic (2020), and Digital Dashboard (forthcoming). A full list of subjects affecting both labor demand and supply, identifying the topics covered by the report and justifying those that have not been covered, is included in Annex 1. This report contributes to the World Bank Group’s global focus on Jobs and Economic Transformation (JET).6 The JET framework aims to create better jobs for more people through economic transformation. Economic transformation is driven by job-creating private investment and more productive workers and entrepreneurs. The elements of the JET framework are shown in Annex 2, and the areas covered by this report are highlighted. 1.1. Overview of priority areas The report provides in-depth analyses and recommendations for: 1) the business regulatory environment; 2) FDI; 3) access to productive finance; 4) innovation and entrepreneurship; and 5) participation in GVCs. Both COVID-19 and traditional challenges and opportunities are addressed for each area. Each chapter concludes with a suggested action plan, which moves beyond macro-analytics to provide actionable reform guidance. The paragraphs below provide a brief overview of the priority areas, which are then elaborated in detail in the following five chapters. The selection of areas is designed to be complementary. For instance, the quality of the business environment is a key factor for FDI and provides incentives for firms to innovate. Access to productive finance is critical for firms to finance technology adoption and innovation. FDI can be a key source of technology spillovers and create incentives for local suppliers to upgrade and innovate. Successful upgrading in GVCs depends on sound policies in all of the other areas.7 Business regulatory environment. Regulatory barriers and complicated procedures can reduce new firm entry. They are a constraint to firm growth and innovation, and they limit private sector demand for labor and thus job creation. In El Salvador, high regulatory and administrative costs, as well as discretion in the implementation of business regulations, undermine a level playing field for the private sector. Partly as a results of this challenging business environment, the new entry rate of formal firms has been stagnant over the last decade and is among the lowest in Central America. This has led to a large informal economy, which creates further challenges for the rule- abiding entrepreneurs and companies. A friendly business environment can also facilitate reallocation of capital and labor from firms that are no longer viable due to the COVID-19 crisis to firms that are able to adapt to new opportunities. Over the past 15 years, the governments in office have introduced several reforms to improve the business environment. These include efforts focused on trade facilitation, reducing the administrative tax burden, supporting the use of movable assets as collateral, and standardizing administrative registration procedures. Over the last two years, the Legislative Assembly approved a package of laws to 6See IDA Special Theme JET paper (May 2019) and Development Committee Paper on JET (October 2019). 7The data supporting the analysis presented in this report were collected primarily between February and July 2020, and were updated (where possible) after rounds of feedback with the Government of El Salvador between April and May 2021. Given the dynamism of the current environment, some analyses, relevant at the time of preparation of this report, may not fully reflect the reality of El Salvador at the time of publication. 7 Overview and Introduction strengthen the regulatory governance framework including a Simplified Administrative Procedures Law, and the Secretaria de Innovación presented the Digital Agenda 2020-2030. Yet, many of these laws and policies remain to be fully implemented. To move forward the reform agenda, detailed possible reform actions were identified in the following areas: • Regulatory governance and predictability in implementing laws and regulations • Digital readiness • Lower the cost of doing business in the formal sector • Reduce the costs and times of trading across borders through trade facilitation • Property rights, institutional quality and contractual environment Foreign direct investment. FDI has been a key driver of economic growth and creator of jobs for high-growth countries. FDI has the potential to confer significant benefits to recipient countries by allowing them to import ideas, technologies, and know-how from the rest of the world, which spur productivity, innovation, and importantly, create better jobs. FDI can also facilitate the upgrading of local suppliers and their entry into GVCs. Between 2013 and 2018, new FDI projects in Latin America helped create nearly 1.4 million new jobs.8 While El Salvador has had some success in attracting FDI, there is much more to be done to capitalize the potential benefits. Most of the FDI received has been concentrated in a narrow number of sectors, with limited effects on the creation of sustainable growth and quality employment. Retaining existing investment (which could be at risk due to the COVID-19 crisis), better use of strategic investment in established sectors, and attracting new investments in additional sectors all represent opportunities for El Salvador’s recovery and growth. Suggested reforms relate to • Strategic framework for FDI attraction • Institutional framework for FDI attraction • Legal and regulatory framework for investment facilitation • Linkages and stimulation of GVC participation • Investment incentives • Additional post-COVID-19 measures Access to productive finance. Access to finance is critical for firms to invest and grow. It is also critical to cover liquidity needs during the COVID-19 crisis and prevent otherwise healthy firms from becoming insolvent. Yet, it is a key constraint for smaller Salvadoran firms: only 30 percent of small firms report having a bank loan or a line of credit versus 61 percent of medium and 79 percent of large firms.9 El Salvador has made important strides to promote financial inclusion in the last decade. However, significant challenges remain with respect to access, quality and use of financial services, as well as the system’s enabling infrastructure to bring their benefits to smaller firms. Recommended actions relate to: • Regulation and supervision • Emergency liquidity assistance framework • State-owned banking system framework (including strengthening second-tier operations for loans and guarantees to address COVID-19 firm financing needs) 8 Financial Times’ fDi markets database 9 World Bank Enterprise Survey, 2016. 8 Overview and Introduction • Financial inclusion Innovation and entrepreneurship. Business innovation—the introduction of new products, technologies, business processes, and ideas in the market—plays a central role in improving firm productivity and economic growth. In the case of El Salvador, innovation need not mean creating new-to- the-world products. Innovation through adopting and adapting technologies and business practices used elsewhere can be a powerful tool. Innovative firms are more likely to become high-growth firms, which create the most jobs. El Salvador needs to encourage the development of innovative entrepreneurs if it is to create attractive jobs for the future. Moreover, Salvadoran firms will need to be innovative to adapt to changing demands and business model requirements if they are to survive and build back better from the COVID-19 crisis. Government can play a critical role in creating an innovation and entrepreneurship-friendly business environment, including supportive financing and advisory programs. El Salvador’s national innovation and entrepreneurship ecosystem is still at a nascent stage. Existing support programs are fragmented and lack a critical mass of beneficiaries. Understandably, they are not yet tailored for the firm COVID-19 recovery needs. Recommended reform actions relate to the following themes: • Innovation and entrepreneurship ecosystem governance • Firm capabilities / training • Business adaptation, technology adoption, and innovation grants • Entrepreneurship • Local ecosystems • Linkages with knowledge providers Participation in global value chains. Strategic repositioning into higher-value segments of GVCs can create more and better jobs in El Salvador. The COVID-19 crisis could also bring opportunities for El Salvador to reposition itself in GVCs, as multinational enterprises look to reduce risk and increase the resilience of production networks. El Salvador’s current participation in GVCs is focused on low value - added manufacturing products—partly, through maquila arrangements with U.S.-based companies. Textiles and apparel are the main contributors to job creation, mostly through unskilled jobs. Recent trends in international markets offer opportunities for repositioning El Salvador toward more sophisticated segments of agricultural and fishing, manufacturing, and services GVCs. Government policies can support upgrading through improving infrastructure, fostering human capital, enhancing the provision of sector-specific public goods, improving market access and FDI attraction, and digitalization. The chapter identifies 8 value chains with representative challenges and offers policy recommendations to strengthen the value chain segments with potential.10 The value chains addressed in this chapter are: • Coffee: small batch / specialty coffee • Cocoa: bean to bar cocoa • Seafood: ready to cook fish and shrimp • Tropical fruits • Textiles: sustainable fashion 10 These chains were selected for analytical purposes, based on interviews conducted near the end of the previous administration, and therefore do not necessarily reflect the nation's current priorities. Likewise, the selection of these chains does not imply prioritization of these sectors and industries over other potential sectors by the World Bank. 9 Overview and Introduction • Wood products • Tourism: explorer /adventure tourism • BPO Services 1.2. COVID-19 impacts on firms and policy responses The COVID-19 pandemic is damaging otherwise healthy firms in El Salvador through multiple channels. Smaller firms are particularly vulnerable. Economic shocks are being transmitted through falling demand, reduced and disrupted input supply, tightening of credit conditions, and rising uncertainty. Table 1 summarizes the types of economic shocks and affected firms. Table 1: COVID-19 economic shocks Shutdown shock Demand shock (beyond Financial shock Uncertainty shock shutdown) Description Result of health measures Reduced consumer and Reduction of financial Uncertain global to reduce contagion. business demand due to intermediation and economic Simultaneous supply and global shutdowns, credit allocation due to conditions likely to demand shock. recession, value chain deterioration of dampen business disruptions (also a banking assets and investment and supply shock). increased risk risk-taking Duration 8 months? 1-1.5 years? 1 year? 1.5 years? Affected Non-essential businesses, Manufacturing, Particularly firms with Particularly firms firms especially travel/ tourism, particularly durables less robust pre-crisis with investments hotels, restaurants, and exports (strategic access to finance, e.g. that have uncertain entertainment, personal firms/sectors) micro, small, young, returns (e.g. services, retail (except Tourism, due to slow and innovative firms innovation) and food and pharmacies) resumption of global long payoff periods travel Source: Authors’ elaboration. Sectors that are highly exposed to COVID-19 economic impacts account for about one-third of El Salvador’s economy. Data on formal employment from the Salvadoran Social Security Institute give a rough estimate of the number of firms and workers in sectors that are particularly vulnerable to the shutdown shock and demand shock (beyond the shutdown). The numbers do not provide evidence of actual impact of the shock, but rather show the size of the sectors likely to be hit the hardest. Highly affected sectors include nearly 16,000 formal firms and 300,000 formal workers, accounting for 31 percent of formal employment (Table 2). Adding informal firms and workers would make these numbers much higher. These exposure estimates give an indication of the magnitude of potential policy responses that could target highly affected sectors. 10 Overview and Introduction Table 2: Sectors in El Salvador exposed to shutdown and demand shocks Number of formal Number of Share of formal Wage bill ($ establishments formal workers employment millions) Shutdown sectors Hotels and restaurants 2,140 32,537 3.4% 146 Tourism 2,043 26,406 2.7% 154 Retail, excluding food and 8,323 104,297 10.8% 548 pharmacies Entertainment 309 4,096 0.4% 23 Personal services 1,085 7,447 0.8% 33 Sensitive manufacturing 961 93,015 9.6% 421 Subtotal: Shutdown sectors 14,861 267,797 28% 1,324 Demand shock (durable goods 857 26,470 2.7% 163 manufacturing) Total 15,718 294,267 31% 1,486 Note: Sector selection based on “shutdown sectors� identified by Vavra (2020). Source: Author’s calculations using 2018 data from the Instituto Salvadoreño del Seguro Social (ISSS). The results of the most recent World Bank Enterprise Surveys reflect the dramatic impacts of the pandemic on Salvadoran firms and workers, but also suggest an incipient recovery . In the third quarter of 2020, 26 percent of formal businesses in El Salvador were temporarily or permanently closed. However, by the end of the year, the majority of formal businesses (97 percent) were fully or partially operating. Likewise, the impact of the crisis on monthly firms sales has been severe but has diminished over time. Data from the first wave of the Enterprise Surveys show that monthly sales of the median firm had declined by 60 percent compared to the same period of the previous year. By the end of 2020 (second wave of surveys), this figure stood at 25 percent. On the other hand, data from the first wave of the Survey show that about 44 percent of Salvadoran formal firms reduced their workforce, decreased hours worked, or reduced the total number of hours worked. However, in the final part of 2020 and early 2021, one- third of formal firms began to hire workers again (see Annex 3 for more detailed results from the first wave of the Survey).11 Negative impacts on firms can be mitigated by tailored policy responses. Negative impacts include liquidity constraints, difficulties to cover financial obligations, layoffs, businesses closures and bankruptcies, and lower investment and productivity. Impacts vary across firms, depending on their sector, size, ability to adapt, and other factors. Policy responses should be designed to protect livelihoods and put the economy on a solid footing to build back better. Table 3 summarizes the types of firm impacts 11See World Bank. (2021). The Impact of the Covid-19 Pandemic on the Private Sector in LAC. Results for Central America and Sao Paulo. Washington, D.C. 11 Overview and Introduction and possible policy responses. Further details are provided on the policy areas throughout the following chapters in the report. The crisis also brings opportunities for firms to adapt and satisfy new consumer and business demands. For instance, demand is likely increasing for e-commerce, delivery logistics, apps for MSMEs going online and home-based work, tele-health, tele-education, data security services for teleworking. There may also be adjustments to global value chains, as multinational enterprises look to reduce risk and increase resilience, e.g. through nearshoring production. The government can play an important role in facilitating firm adaptations to the post-COVID-19 economy. Table 3: COVID-19 impacts on firms and policy responses Types of impacts on firms Possible policy responses and workers • Strengthen and expand financial sector instruments, e.g. lines of credit and Liquidity problems partial credit guarantees, and develop financial sector products and infrastructure (see Access to Productive Finance chapter) • Strengthen unemployment insurance; time-bound wage subsidies and cash Layoffs transfers12 • Improve insolvency framework (see Business Regulatory Environment Bankruptcies chapter) • Retain existing and attract new FDI; facilitate linkages between FDI and local Reduced investment and suppliers (see FDI chapter) productivity • Strengthen entrepreneurship and innovation support programs to facilitate business adaptations (see Entrepreneurship and Innovation chapter) Opportunities for new • Make it easier to start a business and adjust operations by reducing red tape business models and (see Business Regulatory Environment chapter) repositioning in global • Facilitate repositioning and upgrading in priority value chains (see GVCs value chains chapter) Source: Authors’ elaboration. Salvadoran businesses highlight financing and training as their top needs. When asked in an April survey about what type of support would be required to weather the crisis, the most common response was access to credit. Different types of training and capacity building on how to adapt were also indicated as critical needs, e.g. on digital platforms and marketing (Figure 3).13 A survey conducted by CONAMYPE identified similar needs for financing and training.14 12 Detailed analyses of these social protection-type measures are beyond the scope of the report. 13 Universidad Centroamericana José Simeón Cañas (2020) 14 CONAMYPE (2020) 12 Overview and Introduction Figure 3: Types of COVID-19 support requested by firms Source: Universidad Centroamericana José Simeón Cañas (2020) The Government of El Salvador has taken some swift actions to mitigate the economic impacts of the crisis, but resource allocations and sustained further action is needed. For instance, the government quickly implemented a $300 cash transfer to approximately 75 percent of households shortly after the COVID-19 outbreak. Substantial programs to improve access to finance, particularly for smaller firms, in response to the crisis have been approved by the Legislative Assembly. However, by December 2020, 67 percent of Salvadoran businesses reported not having access to government support programs.15 15 World Bank. 2021. The Impact of the Covid-19 pandemic on the private Sector in LAC. Washington D.C. World Bank Group. It is worth noting that this figure represents a notable increase over the share of firms that reported accessing government support programs during the first wave of business surveys in June 2020 (12.9 percent). 13 Business regulatory environment 2. Business Regulatory Environment The business environment in El Salvador is impacted by an unfinished reform agenda. Over the past 15 years, the government introduced several reforms to improve the business environment. These include efforts focused on trade facilitation, reducing the administrative tax burden, supporting the use of movable assets as collateral16, and standardizing administrative registration procedures17. The pace of reform picked up in 2018/2019 with the approval of a package of laws including the Simplified Administrative Procedures Law. These initiatives may have contributed to an improved private sector perception of the business environment (Figure 4).18 Yet, many of the laws and policies remain to be fully implemented. Key reform areas to complete include regulatory simplification and the adoption of the better regulatory governance agenda across all government levels and agencies, particularly municipalities, trade facilitation, and the implementation of the digital agenda. In addition, particularly in the context of the economic crisis due to COVID-19, it is important to create dispute resolution mechanisms through alternative or conciliatory means, as well as the resolution of outstanding debts with financial system entities or individuals through payment arrangements by regulations issued by the Central Reserve Bank (BCR) and the Superintendency of the Financial System. The data supporting the analysis presented in this chapter were collected mainly between February and July 2020, and were updated (where possible) after rounds of feedback with the Government of El Salvador between April and May 2021.19 Figure 4: Perception of the investment climate in El Salvador, 2008-2019 16 World Bank Doing Business. 17 Law of Uniform Procedures. 18 FUSADES. 2020. Informe de coyuntura legal e institucional: Segundo Semestre 2019. Antiguo Cuscatlán, El Salvador: FUSADES. 19 Given the dynamism of the current situation, some analyses, relevant at the time of preparation of this report, may not fully reflect the reality of El Salvador at the time of publication. 14 Business regulatory environment Source: FUSADES’ Firms’ Dynamic Survey Q4, 2019. Note: Net balance refers to the difference between the favorable and unfavorable perceptions of entrepreneurs presented in percentages. International benchmarks point to continued weaknesses in El Salvador’s business environment. El Salvador ranks 103rd out of 141 in the World Economic Forum’s (WEF) Global Competitiveness Index (GCI) 2019, 91st of 190 on the World Bank Group’s Doing Business (DB) index, and 113th out of 180 in the Corruption Perception Index (CPI) 2019 from Transparency International.20 El Salvador's relative position in these rankings has not improved over the last decade. On the contrary, El Salvador's performance in these indexes has fallen compared to its international peers.21 Based on the recent FUSADES Business Competitiveness Survey, during 2019 corruption and transparency issues discouraged investment in 26 percent of the companies surveyed.22 The high cost of operating in the formal sector, a weak contractual and institutional environment, and an unfinished digitalization agenda hinder private sector growth and competitiveness. Beyond security23, a major concern for businesses and investors, the WEF GCI highlights institutions (132nd) and ICT adoption (105th) as comparatively weak areas. Even in areas where El Salvador compares well, such as trade openness, on closer inspection, its position on non-tariff barriers (98th) and border clearance efficiency (115th) point to administrative inefficiencies in line with other areas of business regulation. Similarly, El Salvador’s results on Doing Business vary substantially (see Figure 5). Thanks to reforms, El Salvador compares favorably on measures capturing the ease of trading across borders, paying taxes, and secured transaction systems. However, common registration and permitting transactions to start and operate in the formal sector remain complex and costly. 20 Transparency International. 2020. “Corruption Perception Index 2019.� Berlin: Transparency International. 21 In 2010, El Salvador ranked 82 (out of 139) in the GCI; 84 (out of 183) in the DB; and 78 (out of 178) in the CPI. This does not necessarily imply that El Salvador's performance in the areas assessed by these indicators has worsened. The decrease in the rankings is partly due to relative improvements in other countries. 22 FUSADES. 2021. Encuesta de Competitividad Empresarial 2019. Competitividad y transformación digital: claves para superar el impacto del COVID-19. El Salvador. 23 Security and crime are a key obstacle to doing business in El Salvador but for the purpose of this chapter will not be covered. The country ranks 140th of 141 on security on the WEF GCI. The 2016 Enterprise Survey showed that 29% of firms identify crime, theft and disorder as the biggest obstacle to their business. Larger firms are more likely to be targeted by criminal organizations. Older and formal firms are also more likely to be crime victims than younger and informal ones. This weakens the incentives to grow and become formal. During 2017, from the 19% of firms that were crime victims, 11% were large companies while 9% were micro, small and medium sized. For those firms that are already large, the cost of crime and violence constitutes a tax on their profitability making them less competitive in comparison with their global peers. Estimates from the Institute for Economics and Peace (IEP) indicate that the cost of violence in El Salvador could represent as much as 22% of GDP, making El Salvador the 10th country out of 163 with the highest cost of violence in the world, just below Venezuela (30%) and Colombia (25%) from the LAC region. This may also be one of the main reasons behind the deterioration on the WGI index. Between 2014 and 2018, El Salvador decreased its score from 36.5 to 19.7 points, performing below LAC and CA averages. The World Bank’s WGI report assesses the quality of the rule of law by measuring the extent to which agents have confidence in and abide by the rules of society in quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. 15 Business regulatory environment Figure 5: El Salvador’s performance on GCI 2019 and DB 2020 Source: WEF and DB databases. Note: The GCI does not include Belize. The comparatively high cost and complexity of entry, operations and exit may inhibit firm entry and growth in the formal sector. Regulatory barriers and high administrative costs have been identified as a binding constraint for new firms to enter and for existing firms to grow, limiting the private sector demand for labor and thus job creation.24 Discretion in the implementation of business regulations can leave room to favor specific incumbent firms, creating de facto barriers to market entry for new entrepreneurs.25 For the last ten years in El Salvador, the new entry rate of formal firms has been stagnant and among the lowest in Central America (Figure 6).26 Figure 6: New businesses entry rate in El Salvador and Central America Source: Doing Business based on World Bank’s World Development Indicators. Note: Central America average only includes 5 countries out of 7 since no information is available for Honduras and Nicaragua. 24 Arnold et al., 2008; Barseghyan, 2008; Barone et al. 2011. 25 See Pritchett et al., 2017. In the case of El Salvador, the results of FUSADE's 2019 Business Competitiveness Survey suggest that uncertainty about economic policies, corruption, and lack of transparency discourages investment by a significant fraction of firms in the country 26 World Bank’s World Development Indicators, 2018. 16 Business regulatory environment Successful business environment reforms will need an appropriate strategy and institutional setup for their implementation. These reforms have become even more urgent to support economic recovery in the context of the COVID-19 crisis. Improving the business environment will entail measures to reduce the cost of doing business, increase predictability, strengthen the contractual environment, the simplification of procedures and the increase of security of property rights. Reforms will have to be implemented in a broader context with significant challenges related to low levels of education, crime and violence, and lack of ICT adoption. This is particularly important for the implementation of the digital government reform agenda.27 Furthermore, reforms will require effective coordination and accountability mechanisms across public agencies at the national and municipal level. The COVID-19 crisis exacerbates these challenges while increasing the urgency of improving the business environment to support economic recovery. Legal and regulatory reforms can facilitate the reallocation of resources and help firms better cope with the challenges posed by COVID-19 pandemic. Such changes are often not costly, an important consideration for fiscally constrained governments such as El Salvador. El Salvador can look to implement cost-effective reforms, such as decreasing the burden of regulatory compliance, while improving the operational flexibility of nascent enterprises and cash-constrained firms alike. Strengthening procedures and institutions to facilitate entry, debt resolution, and exit will be key for effective resource allocation. Currently, the judiciary is characterized by inefficient bankruptcy proceedings, a lackluster land administration system, and high lead times to resolve commercial disputes. Another area of concern is the lack of e-government services. Not only is ICT infrastructure lacking, but the legal framework is not adapted to digital business models (e.g. e-commerce, sharing economy, fintech).28 Finally, the perceived capacity of the government to roll-out policy actions can be improved. Based on the World Bank's 2019 Worldwide Governance Indicators, El Salvador ranks among the lowest countries in the region on the perception of the quality of public services, as well as the degree of its independence from political pressures and the quality of policy formulations. 27WEF GCI. 28The WEF GCI ranks El Salvador among the three worst economies in LAC on the adaptability of the legal framework to digital business models. 17 Business regulatory environment Improving digital readiness of the Figure 7: El Salvador lags behind most Latin American public and private sectors can support countries when it comes to e-government businesses during the reopening and recovery period. Governments that have Mexico invested in e-government services and digitization have been better prepared to Colombia continue functioning in the context of social Peru distancing. Since some social distancing Panama measures are expected to continue, countries with sound e-government infrastructure and LAC Average services are also better positioned during the Dominican Republic re-opening phases. Several countries are Paraguay using the crisis to fast-track the digitization agenda. Israel, for example, proposed a Bolivia government information highway for data- Venezuela, RB sharing among ministries and a virtual 0 20 40 60 80 personal zone for government services Government e-service score (0-100) organized around the citizen or firm. The Note: the government e-service scores are an average of three measures: current lack of a centralized system for (i) the UN e-government survey, (ii) the Online Government Service Score information sharing and coordination among of the Global Innovation Index, and (iii) the Legal Framework Adaptability public agencies not only has a cost29, but it of the WEF Global Competitiveness Index. also impacts the efficiency of government support in COVID times. Self-employed Israelis recently had to wait until a dedicated website for a “coronavirus grant� was set up, so they could apply—even though they had already supplied the same information in the past to the tax authority.30 Greece is another example where the government aims to harness the crisis to enact long-overdue digital reforms to protect citizens’ health and modernize the state. The government plans for all government-to-business (G2B) and government-to-consumer (G2C) services will be offered through a single government website (gov.gr).31 Improving the business environment may contribute to reducing the size of the informal sector and, in turn, increase the effectiveness of support measures in the long term . This will, ultimately, increase not only the reach of public policy measures but also public revenue from taxes. It will also level the playing field. Almost 70 percent of formal firms find themselves competing against informal businesses.32 Based on an assessment of available data, analytics, firm surveys and interviews, this chapter covers five areas relevant to improving the business environment in El Salvador. These are: i) regulatory governance and predictability in implementing laws and regulations; ii) digital readiness; iii) cost of entry, 29 According to the Israel state comptroller, reducing excessive bureaucracy by 30%, would add 58 billion shekels ($ 16.2 billion) to the economy. 30 https://www.haaretz.com/israel-news/.premium-israeli-government-plans-major-new-digital-drive-if-unions-don-t-block-it- 1.8785255 31 https://mindigital.gr/archives/1277 32 World Bank Enterprise Survey 2016 for El Salvador. 18 Business regulatory environment exit and conducting every-day business in the formal sector (such as registration, permitting and licensing requirements); iv) trade facilitation, and v) property rights, institutional quality and contractual environment. Detailed policy recommendations reflecting private sector priorities33 and relevance for recovery from the COVID 19 crisis are presented in the suggested action plan at the end of the chapter. 2.1. Regulatory governance and predictability in implementing laws and regulations Perceived government effectiveness in El Salvador weakened during 2014-2018. The Worldwide Governance Indicators’ (WGI) government effectiveness component reflects, among other aspects, perceptions of the quality of policy formulation and implementation. Between 2014 and 2018, El Salvador showed the biggest downward trend on the WGI’s government effectiveness index, with a decline of almost 18 percentage points (Figure 8). Figure 8: WGI’s Government effectiveness scores for 2018 and its evolution in time in CA Source: Worldwide Governance Indicators 2019. (Lack) of certainty on economic policies affects private investment levels in El Salvador. Based on FUSADES’ Entrepreneurial Competitiveness Survey, more than thirty percent of companies that invested during 2017 identified “uncertainty in economic policies� as the third biggest reason that disincentivizes investment. Moreover, among the firms that did not invest during the same period, almost 40 percent of them identified economic policy uncertainty as their main reason for not investing. However, El Salvador appears to be making progress in this area. According to the 2019 Business Competitiveness Survey, among companies that invested in 2019, certainty in economic policies played an important role in their investment decision. In other words, between 2017 and 2019, certainty went from being a disincentive to being an incentive for investment.34 33 Interviews were conducted with representatives from the Cámara de Comercio de El Salvador (CAMARASAL), Fundación Salvadoreña para el Desarrollo Económico y Social (FUSADES), American Chamber of Commerce (AMCHAM), Cámara Salvadoreña de la Industria de la Construcción (CASALCO), and others. 34 FUSADES. 2021. Encuesta de Competitividad Empresarial 2019. Competitividad y transformación digital: claves para superar el impacto del COVID-19. El Salvador. 19 Business regulatory environment Private sector involvement in the regulatory design processes is key. Given the absence of a formal mechanism for public consultation, the Regulatory Improvement Agency (OMR) and the Access to Public Information Agency (IAIP) launched the Legisla website in 2018. Legisla allows citizens and the private sector to review and comment on regulatory drafts. Over the last two years, the electronic portal had 15 consultation processes with 435 comments.35 Article 161 of the Administrative Procedures Law (LPA) recognizes within the regulatory process the hearing of interested parties, as well as the participation of the general public. However, according to a diagnosis prepared by the OECD, participation is limited to regulations that have already been drafted, and there is no consultation process for early stages of the regulatory design (before an initiative has been drafted).36 A new regulatory governance framework was passed but has not been fully implemented. In 2018/2019 El Salvador passed relevant laws aimed at introducing greater regulatory predictability. These include the LPA, the Law of Better Regulation (LMR), and the Law for Elimination of Bureaucratic Barriers. The LPA regulates the validity of the actions of the Public Administration and the efficiency of the acts issued by the same, as well as it intends to standardize the application of the contesting means that citizens have to exercise control over the administrative acts issued by the same Administration. Likewise, the LPA enables the use of eSignatures; and mandates to make publicly available information for administrative requirements; and to eliminate unnecessary requirements, and establishes response times for administrative acts and supplementary timeframes for sector-specific regulations. On the other hand, the LMR establishes clear competencies for the OMR, which is in charge of managing the “Regulatory Reform System�, the implementation of the “National Procedures Registry� (RNT), ex-ante and ex-post “Regulatory Impact Assessment� (EIR), guiding regulatory agendas, and leading administrative simplification actions across El Salvador. Since April 2019, the EIR has been implemented and to this date, the Ministry of Health (MINSAL) and the Ministry of Environment and Natural Resources (MARN) have been pioneers in this process. At the same time, the private sector raised concerns about the lack of support and hence capacity of the OMR to conduct its work, hindering the regulatory improvement process. Lastly, the Law for Elimination of Bureaucratic Barriers creates the “Elimination of Bureaucratic Barriers Tribunal� (TEBB), which is responsible for eliminating administrative requirements without a legal basis.37 However, TEBB’s members have not been appointed, although this law entered into force in early 2019. Greater stakeholder engagement and private sector consultation in the formulation of policies are needed. The OECD assesses the quality of regulatory policy practices through its “Indicators of Regulatory Policy and Governance� (iREG).38 The iREG covers three main dimensions: “ex ante Regulatory Impact Assessment�, “Stakeholder engagement� in the design of new regulations, and regulatory “Ex post 35 Website visited on April 10, 2020. See https://participacion.iaip.gob.sv/. 36 OECD. 2020. Government at a Glance: Latin America and the Caribbean 2020, OECD Publishing, Paris. 37 Decree 856 from February 2018, “Ley de Procedimientos Administrativos�. Decree 202 from January 2019, “Ley de Mejora Regulatoria�. Decree 201 from January 2019, “Ley de Eliminación de Barreras Burocráticas�. Other relevant laws that strength the regulatory governance framework are the “Ley de Acceso a la Información Pública� from 2010 and the “Ley de la Jurisdicción Contencioso Administrativa� from 2017. 38 Arndt, C., et al. 2015. "2015 Indicators of Regulatory Policy and Governance: Design, Methodology and Key Results", OECD Regulatory Policy Working Papers, No. 1, OECD Publishing, Paris. 20 Business regulatory environment evaluation and administrative simplification�.39 In 2019, the OECD assessed ten LAC countries, extending iREG results beyond its member countries. El Salvador, while performing better than Peru, Ecuador, Dominican Republic, and Chile, is still below the regional average (Figure 9).40 Figure 9: Stakeholder engagement in developing subordinate regulations for selected LAC countries (OECD iREG for 2015 and 2019) Source: OECD database. Note: “Methodology� gathers information on the methods used in each regulatory area, e.g. the type of impacts assessed or how frequently different forms of consultation are used; “Systematic adoption� records formal requirements and how often these requirements are conducted in practice; “Oversight and quality control� records the role of oversight bodies and publicly available evaluations; “Transparency� records information that relates to the principles of open government, e.g. whether government decisions are made publicly available. While half of LAC countries have undertaken administrative simplification processes at the regional or municipal level, El Salvador is not one of them . A number of countries in the region have focused their efforts on administrative simplification41 and in the last four years have undertaken reforms to improve their administrative processes and reduce compliance costs.42 Although the new regulatory governance legal framework for El Salvador is applicable to national agencies and municipal authorities, administrative simplification processes have only been implemented at the national level (Figure 10).43 The LMR sets forth a gradual implementation of the regulatory improvement policy throughout the country. Article 38 sets forth that the law will be mandatory for municipalities by January 2023, with the possibility of accelerating its implementation through the voluntary subscription of agreements with the OMR. For this purpose, the capacities and resources of the OMR must also be strengthened. This is an important agenda to be considered going forward, in view of the fact that regulatory interactions with 39 These three dimensions are measured across four categories: Methodology, Systematic adoption, Transparency, and Oversight and Quality Control. 40 OECD. 2020. Government at a Glance: Latin America and the Caribbean 2020 , OECD Publishing, Paris. 41 The concept of administrative simplification refers not only to the simplification of procedures, but also includes the simplification of the regulatory framework (e.g. laws and secondary regulations that provide the legal basis for procedures), as well as the reengineering of processes and the implementation of electronic tools for managing procedures and, if necessary, institutional restructuring. 42 Some examples of administrative simplification programs are “Simplifica� from Mexico, “RD+ Simple� from the Dominic an Republic, and “Trámites a Distancia� from Argentina. 43 OECD. 2020. Government at a Glance: Latin America and the Caribbean 2020, OECD Publishing, Paris. 21 Business regulatory environment municipalities have been identified by businesses as among the most problematic and the variance in the implementation of national regulations and fee structures among municipalities is significant. Figure 10: Level of government at which administrative simplification processes have taken place in LAC countries National, Regional, and Municipal Only National El Salvador Source: OECD database. Awareness and coordination of the new regulatory governance framework represent an important challenge for its implementation. As in any reform process, awareness and coordination problems during implementation may appear. To mitigate such challenges, in 2019 the OMR delivered training to public officials from different ministries on the LMR application, including the implementation of the RNT, EIR, and the Regulatory Improvement Agenda. OMR also reported that guidelines for different regulatory governance tools (RNT, EIR, regulatory agendas44, administrative simplification actions), as well as of the LMR’s secondary regulation draft, are under review. Training on the LPA was provided to all Executive Branch institutions by the former Technical and Planning Secretariat of the Presidency. Similarly, the National Judiciary Council (CNJ) delivered training on applying the LPA to public officials from the Pensions Agency (INPEP) and the Social Security Agency (ISSS).45 These results show that the government is on the right track. Article 15 of the LMR sets forth the Regulatory Improvement Agenda as a tool to "make the process of creating regulations transparent, provide predictability to the regulatory exercise, facilitate inter-institutional coordination and enable citizen participation". In this sense, the Ministry of Economy (MINEC), the Ministry of Agriculture and Livestock and MINSAL published during 2020 their regulatory improvement agendas. For instance, MINSAL's agenda included 24 different regulations related to bylaws, technical standards, or procedures manuals to be promulgated during 2020.46 Likewise, MARN and the Ministry of Housing have already prepared their regulatory agendas for 2021. This gives certainty to the regulated sectors and allows for a public-private dialogue. 44 LMR (art. 5 and 15) establishes that each central government, autonomous public institution and municipality shall publish a regulatory agenda, listing the laws, norms, regulations and procedures that will be approved, proposed, amended or removed, following OMR’s guidance. 45 FUSADES. 2020. Informe de coyuntura legal e institucional: Segundo Semestre 2019. Antiguo Cuscatlán, El Salvador: FUSADES. 46 Ministry of Health, 2020: http://asp.salud.gob.sv/regulacion/pdf/otrosdoc/Agenda-Regulatoria-para-el-anio-2020-MINSAL.pdf 22 Business regulatory environment Before 2018, El Salvador not only had a weak regulatory governance framework, but its private sector had no mechanism to participate in the design of regulations. In order to address this situation, the government initiated an ambitious reform that created the necessary legal framework to provide ad hoc mechanisms for public consultation, ex ante and ex post regulatory impact assessment, as well as publication of the information regarding the different regulations for citizens and businesses at the national and municipal level. Nevertheless, one challenge is the participation of and coordination with municipal authorities in the regulatory reform process. For instance, although the new LMR establishes that the National Procedures Registry should include information for national and municipal regulations. This registry is currently under development by the OMR. However, the website “Infotramites eRegulations�, where, for the moment, information on different procedures can be consulted, for example, only includes information for San Salvador and Santa Tecla regarding one municipal procedure each, leaving other regulations from these cities and the rest of the municipalities out.47 It is worth noting that this website is only available in Spanish and it would be desirable to have an English language option for foreign investors. The implementation of this reform is at an early stage. The institutions in charge of the regulatory governance process need to be consolidated and the design of the different bylaws and guidelines should be concluded to ensure the correct implementation of these policies. It is important that the regulatory policy has sufficient support at the highest level to accelerate the impact of its implementation, starting with the ministries of the Executive Branch, which are the first group of subjects compelled by the LMR. Box 1: International good practice examples: high impact regulatory reform In Mexico, the 2017 Constitutional reform established that authorities from all levels of government (Federal, State and Municipal), as well as the legislative and judicial branches, should implement regulatory improvement (RI) policies. As a consequence, the General Law for RI was promulgated on May 18, 2018 and the National Commission for RI (CONAMER) was created.48 The new General Law for RI also established the National System for RI, which is executed based on the RI National Strategy and implemented by the RI National Council. At the same time, the National Council is comprised by the Federal, State and Municipal governments, as well as by the National Observatory for RI, a private think tank. With the new law, each State and Municipality should create a RI coordinating authority led by a high-level official (e.g. undersecretary or equivalent). CONAMER is responsible for designing the RI national agenda, guidelines and tools. Members of the RI National Council should harmonize their policies to this national framework. This reform provides a comprehensive coordination mechanism among the federation, states and municipalities. In parallel, CONAMER leads specific RI subnational programs in coordination with States and Municipalities: • Administrative Simplification Program (SIMPLIFICA): Measures the economic costs of procedures and recommends simplification and modernization actions. Between 2017-2019, CONAMER reviewed 18,500 procedures from 1,129 agencies across 20 states and 12 municipalities. • Simplified Window for Construction Permits (VECS): Introduces a single window to grant construction permits in 10 days maximum for low risks constructions of less than 1,500m2. 47 See https://tramites.gob.sv/. Website visited on April 21, 2020 48 CONAMER replaces the Federal Regulatory Improvement Commission (COFEMER). 23 Business regulatory environment • Commercial Oral Proceedings Program (JOM): Promotes the homogeneous implementation of commercial oral proceedings in courts across the 32 States. • Priority Sectors Reform Program (PROREFORMA): Improves the national regulatory framework of specific economic activities or sectors. • System for Quick Business Start-Up (SARE) and SARE’s quality certificate (PROSARE):49 This program started in 2002 and by 2018, 331 SARES have been rolled out across Mexico. Between 2014-2018, SARES generated 6,681 firms and 26,850 jobs. Research found that the implementation of this reform increased the number of registered businesses by 5 percent and employment by 2.8 percent in eligible industries. Moreover, the competition from new entrants lowered prices by 0.6 percent.50 Source: CONAMER. 2.2. Digital Readiness El Salvador has increased efforts towards digitalization over the last 6 years, including through the recent Digital Agenda, but much work remains. In 2014, the government implemented a bylaw on Information and Communication Technologies (ICT) use for public entities. The Electronic Signature (eSignature) Law was passed in 2015, but since then the eSignature has not been implemented due to lack of accreditation and certification mechanisms.51 In 2016, the Cybercrime Law was published and from 2018 to 2020 the Consumer Protection Law was amended to cover, among other aspects, online purchases.52 This law imposes criteria, which in some cases goes beyond international standards (e.g. it requires businesses to adopt specific cyber security programs, to publish their taxpayer registration number and the legal business address, among other strict requirements), making it harder and more expensive for businesses to comply. In 2018 the National Open Data policy was created,53 which aims to guarantee open and free access to datasets produced by the government, while reinforcing the law on access to information.54 In 2019 the Electronic Commerce (eCommerce) Law was approved by the Legislative Assembly. Nevertheless, it has not been signed by the President and, hence, could undergo further modifications. In October 2019, the Electronic Commerce Law (e-Commerce) was approved and entered into force in February 2021.55 Additionally, in April 2021, the "Personal Data Protection and Habeas Data Law" was approved by the Legislative Assembly.56 Currently, the Law is under review by the Presidency and is pending material publication in the Official Gazette and its entry into force. This law provides for the creation of a National Digital Authority that will regulate the use of information and 49 SARE is a risk-based approach to business start-up. Businesses with low risks activities can go through a fast track incorporation process wherein commercial licenses are granted within 72 hours. PROSARE certification recognizes that a business is opened in less than 72 hours using one single registration form and with no more than two visits to the SARE module. Based on an evaluation, this certificate can be renewed every one, two, or three years. 50 Bruhn, Miriam (2008). “License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico �. Policy Research Working Paper No. 4538. World Bank, Washington, DC. 51 Decree 24 from July 2014, “Reglamento para el Uso y Control de las Tecnologías de Información y Comunicación en las Entidades del Sector Público�. Decree 133 from October 2015, “Ley de Firma Electrónica�. 52 Decree 260 from February 2016, “Ley Especial Contra los Delitos Informáticos y Conexos�. Decree 51 from July 2018, Decree 282 from April 2019, and Decree 602 from March 2020, “Reformas a la Ley de Protección al Consumidor�. 53 The National Open Data policy was created by the Technical Secretariat and Planning and the Secretariat of Participation, Transparency and Anticorruption of the Presidency. 54 Ministry of Innovation: https://www.gobiernoelectronico.gob.sv/?p=770. 55 See Link. Website visited on April 21, 2021. 56 See https://www.asamblea.gob.sv/node/11202. Website visited on May 12, 2021. 24 Business regulatory environment communication technologies. This entity will be a public law institution, with legal personality, its own assets and administrative and budgetary autonomy.57 Intellectual property rights, especially of copyrights and patents, are also key to promote investment in the digital services sector. El Salvador is signatory of the World Intellectual Property Organization (WIPO) treaties and has experienced important changes in its legal system as a result of the entry into force and application of the LPA, which has enabled the use of ICTs in the administrative sphere and expedited registry services. The foregoing, together with the specific domestic legislation on intellectual property and the treaties managed by WIPO. It is important to highlight that in 2020, El Salvador climbed 16 positions in the Global Innovation Index, with respect to 2019, placing the country in position 92 out of 131. Nevertheless, there are still areas of opportunity. For example, software development entrepreneurs complain that the patents and trademarks registration process is too long for the technological turnaround and the required speed to market for this industry.58 Currently, MINEC, together with the National Registration Center (CNR), is working on the elaboration of 11 regulations on intellectual property rights. Lack of policies that foster a digital environment inhibits the benefits of eGovernment and eCommerce in El Salvador. El Salvador is lagging in terms of digital readiness as illustrated by international benchmarks that assess the degree of adoption of ICT, innovation, as well as eGovernment and eCommerce practices (Table 4). For instance, El Salvador does not have a national cybersecurity strategy. As provided for in the National Digital Agenda, the Secretariat of Innovation will lead different efforts to develop a strategy that addresses cybersecurity issues and promotes economic and social prosperity in a secure digital environment.59 57https://www.elsalvador.com/noticias/nacional/asamblea-aprueba-ley-proteccion-datos- personales/830328/2021/#:~:text=Con%2056%20votos%20la%20Asamblea,Escobar%2C%20impulsora%20de%20la%20ley. 58 In the case of entrepreneurs dedicated to software development, in El Salvador these rights are safeguarded under the declaratory right acquisition system. The government reports that currently the software deposit procedure can be carried out entirely online and with average response times of eight hours or less. In the case of distinctive signs (trademarks), the government also mentions that response times have been improved and they are working on the online application filing platform with the creation of the "Intellectual Property Agents Base". In the case of patents, the CNR, the MINEC, the Innovation Secretariat of the Presidency and the Trade and Investment Secretariat, together with WIPO, are working on the establishment of the "National Innovation Ecosystem", which includes the implementation of the new "Technology and Innovation Support Centers" ("Centros de Apoyo a la Tecnología e Innovación" CATIS), in order to promote the filing of applications for national patents, utility models and industrial designs. 59 See World Bank (forthcoming), Central America Digital Economy: Enabling Environment Assessment, for more information on cybersecurity challenges and recommendations in El Salvador. 25 Business regulatory environment Table 4: El Salvador’s performance on international benchmarks related to ICT adoption and digital practices Source Index or Indicator Rank Year World Economic Forum ICT adoption pillar 105th out of 141 2019 World Economic Forum Legal framework's adaptability to 124th out of 141 2019 digital business models World International Property Organization Global Innovation Index 92th out of 131 2020 International Telecommunications Union ICT Development Index 119th out of 176 2017 United Nations E-Government Survey 100th out of 193 2018 World Bank Group Digital Adoption Index 95th out of 183* 2016 Portulans Institute Network Readiness Index 94 out of 121 2019 International Telecommunications Union Global Cybersecurity Index 142 out of 175 2018 Note: The Digital Adoption Index does not publish rankings, therefore the rank for El Salvador was estimated based on its score. Challenges to developing the digital economy relate to both supply and demand for digital services. As of 2018, although mobile telephone penetration in El Salvador registered high levels with more than 146 subscriptions per 100 inhabitants (the 18th highest in the world), mobile broadband subscriptions were below 55 subscriptions per 100 inhabitants, while Costa Rica’s rates were almost 95. When it comes to fixed broadband, penetration was only 7 subscriptions per 100 inhabitants. Overall, less than 35 percent of the 10 years and older population use the Internet.60 However, Internet penetration rates significantly differ across the country. While in 2018 Internet connections in households stood at 32 percent in urban areas (and 38 percent in San Salvador Metropolitan Area), for rural areas it was only 3 percent.61 Among other sociodemographic and economic aspects, low use of ICTs and Internet could be explained by lack of skills and trust from consumers (demand side), as well as insufficient telecommunications infrastructure (supply side). Even if eGovernment platforms are introduced to provide online public services and digital governance policies are implemented to incentivize eCommerce, given the low levels of Internet use in El Salvador only a small part of the population will benefit from what the digital environment offers. Under these circumstances, comprehensive educational programs and socialization campaigns should aim to increase ICT skills. From the supply side, in order to have effective competition and affordable services, regulatory telecommunication policies should foster infrastructure deployments (including infrastructure sharing), specially of fiber optics, as well as enough radioelectric spectrum allocation that extends coverage and enables 5G mobile network implementation. Nonetheless, the private sector in El Salvador has highlighted a lack of support from the government for telecom operators and tower companies to deploy the necessary infrastructure, particularly in rural areas62 where deployment costs are higher and service provision less profitable. eCommerce in El Salvador is underdeveloped. Based on UNCTAD’s B2C E-Commerce Index 2019, El Salvador ranks 110th out of 146, just above Nicaragua (132nd) and below the rest of its Central American neighbors. The FUSADES' 2019 Business Competitiveness Survey indicates that only 21.7 percent of MSMEs 60 ITU database. Data from 2018 except for “Internet users� from 2017. 61 Ministry of Economy. 2019. Encuesta de Hogares de Propósitos Múltiples 2018. Dirección General de Estadística y Censos. Delgado, El Salvador. 62 AmCham El Salvador. Presentation to World Bank staff on February 26, 2020 in San Salvador, El Salvador. 26 Business regulatory environment had their own website, compared to 37.3 percent for large companies that have their own website.63 Among the firms that reported not having their own website, 58.4 percent of firms reported that the reason why they do not have a website is because it is not useful for their business, 16.4 percent because it was not affordable, nine percent due to concerns about security for the business, and seven percent because they were not familiar with the technology.64 Further reforms are needed to encourage the adoption of digital business models in the public and private sectors, particularly in light of the COVID-19 crisis. The crisis has accelerated the need for efficient digital services at all levels, including G2B, G2C, B2B, and B2C. Although the Secretariat of Innovation plays a relevant role in the digital agenda, El Salvador ranks last among Central American countries (124th out of 141) in the WEF’s “Legal framework's adaptability to digital business models� indicator. El Salvador’s government has not yet adapted its legal framework to digital business models, such as eCommerce, sharing economy, fintech, etc. This is also indicative for government services. For example, a basic Government-to-Business (G2B) service is the registration of companies. El Salvador has a centralized business registry with full national coverage, an electronic database to search all company records, as well as the possibility of electronic exchange between the registry and agencies. However, not all registered company records are stored in digital form, there is no electronic system that covers the entire company registration process, and electronic payment for all fees related to company incorporation is not possible. It is also not possible to use eSignatures for companies’ registration and there is no unique business identification that all government agencies can use.65 The Digital Agenda is a high priority for the government. In 2019 the Ministry of Innovation (Secretaría de Innovación) was created and in January 2020 it presented the “Digital Agenda 2020-2030�. The Agenda includes the following pillars: i) Digital identity; ii) Digital Governance; iii) Government Modernization; and iv) Innovation, Education, and Competitiveness.66 This is an important step forward, yet much work remains to ensure full implementation. For instance, missing elements include prioritization of actions, identification of key players and specific responsibilities, key performance indicators and evaluation mechanisms, as well as a budget and funding sources.67 Implementation gaps of enabling legislation and complementary policies, as well as the lack of a comprehensive legal framework, slow down the digitalization process in El Salvador. Different international benchmarks show that El Salvador has a low use and adoption of ICTs and Internet, as well as of eGovernment and eCommerce practices. To address this, since 2014 El Salvador has approved and issued some key regulations and policies, such as the eSignature and eCommerce Laws, and recently the Digital Agenda 2020-2030. For instance, the implementation of the electronic signature will be a useful tool to promote regulatory policy regarding administrative simplification and the reduction of burdens and costs for users in procedures and formalities with the Public Administration. Nonetheless, the digital 63 The World Bank's Follow-up Survey to Enterprise Survey (2020-2021) finds that approximately 50 percent of SMEs in El Salvador have started using digital technologies or have increased their use as a result of the pandemic. 64 FUSADES (2021). 65 Doing Business database. 66 Ministry of Innovation. 2020. Agenda Digital Nacional 2020-2030. Plan de Desarrollo El Salvador Digital. San Salvador, El Salvador. 67 FUSADES. 2020. Informe de coyuntura legal e institucional: Segundo Semestre 2019. Antiguo Cuscatlán, El Salvador: FUSADES. 27 Business regulatory environment framework is incomplete and has been partially implemented or in some areas not implemented at all. Likewise, to boost the digitalization of public institutions and private sector, the digital divide gap should be closed through a combination of educational programs, digital inclusion policies and awareness campaigns aiming to increase digital skills of the population; together with regulatory policies that incentivize investment in infrastructure and level the playing field in the telecommunications sector to increase access to affordable digital services and platforms. 2.3. Cost of doing business in the formal sector Formal firms experience excessive red tape, costly and lengthy government services, and unpredictability due to lack of information or clear rules. According to the FUSADES’ 2019 Entrepreneurial Competitiveness Survey, half of firms report problems or difficulties with public institutions related to administrative inefficiency, bureaucracy and cumbersome procedures and permits. Municipalities (9.6 percent of companies reporting problems), the Ministry of Finance (8.1 percent), the General Directorate of Customs (7.4 percent), MINSAL (6.4 percent) and MARN (4.2 percent) were viewed as the most problematic.68 Registration, licensing, and permitting obligations appear particularly problematic and impact the majority of formal firms operating in El Salvador. More than 92 percent of firms requested a permit from a public institution during 2017, mainly to Municipal Offices, Ministry of Finance, and the National Center of Registries (CNR).69 According to the 2016 WBG Enterprise Survey, obtaining an operational license takes on average 31 days in El Salvador.70 Large firms have to wait almost 3 times longer than small firms. Over the years, El Salvador has implemented a number of reforms to lower the cost of starting a business. In 2004 the “Law of Uniform Procedures� entered into effect, which regulates and standardizes all procedures for all registries administrated by the CNR.71 In 2006, the Government created a single access point at the commercial registry with representatives from the Ministries of Finance and Labor and Social Security. In 2008, reforms to the Commercial Code were introduced, which lowered the minimum capital requirement to USD2000, simplified the legalization of accounting books, abolished the fee for balance sheet registration, and simplified company books’ publication requirements. Later in 2012, the Commercial Registry launched the portal “Miempresa.gob.sv�. However, implementation challenges hamper the impact of the online registration portal. In 2017, El Salvador made company pre-registration mandatory through “Miempresa.gob.sv�. As a result, the number of new registered companies per year increased to 1,186 between 2018 and 2019 compared 68 FUSADES 2021. “Encuesta de Competitividad Empresarial 2019�. Antiguo Cuscatlán, El Salvador: FUSADES. 69 The CNR includes the Registries of Commerce; Real State and Mortgages; Intellectual Property; Secured Transactions; Institute of Geography; and National Cadaster. 70 See https://www.enterprisesurveys.org/en/data/exploreeconomies/2016/el-salvador. Website accessed April 21, 2021. 71 Decree 257 from June 2004 (reformed in 2013), “Ley de Procedimientos Uniformes para la Presentación, Trámite Y Registro o Depósito de Instrumentos en los Registros de la Propiedad Raíz e Hipotecas, Social de Inmuebles, de Comercio Y de Propiedad Intelectual�. 28 Business regulatory environment to 261 on average between 2014 and 2017.72 At the same time, El Salvador continues to have one of the most burdensome processes to open a business in Central America and globally.73 A few factors contribute to this. “Miempresa.gob.sv� has limited online functions. Based on the information provided by the Doing Business 2020 report, all documents can be submitted online during the pre-registration process, but entrepreneurs still have to go in person to CNR and present the hardcopy for obtaining the final registration document physically signed by the registrar. The process still faces institutional coordination problems and the online platform only covers a few municipalities, such as San Salvador and Santa Ana. Since the beginning of the current administration, the Registry of Commerce has prioritized the search to streamline its services, and in the case of opening companies it has carried out a series of actions. For instance, an exclusive "Registrar" was assigned to qualify the incorporations of companies, in order to eradicate the diversity of criteria for this service. In addition, the "Legal Collaborators" who work in the " MiEmpresa" Department were trained to carry out the registration processes. Opening a business is not only complex but also costly. Based on the Doing Business 2020 report, starting a business in El Salvador is the second most costly in Central America. While standardized articles of association are available online, most registrations are done by notaries and their fees represent on average more than 45 percent of the total cost of registering a business.74 Moreover, El Salvador and Guatemala are the only Central American economies that still require a paid-in minimum capital requirement (Figure 11).75 Figure 11: Cost and paid-in minimum capital requirement to open a business in Central America Source: Doing Business database. 72 Estimations based on yearly data provided by the National Office for Investments from the Ministry of Economy of El Salvador. Data for 2019 as of December 20th, 2019. 73 El Salvador ranks 148th out of 190 in the ease of starting a business indicator from the DB report. 74 World Bank Group. 2019. "Doing Business 2020: Comparing Business Regulation in 190 Economies." Washington, DC: World Bank Group. 75 The minimum capital payment requirement is not applicable to partnerships in El Salvador. The minimum capital for the creation of a company can be paid in one year and at the time of registration only 10% of the total must be paid. 29 Business regulatory environment Outdated Commercial and Tax Codes contribute to the complexity and cost of the registration and closure of businesses. In spite of reforms, the Commercial Code imposes outdated requirements. For example, a corporation of two or more partners can only be filed by a notary. It also imposes outdated requirements for business closure.76 Closing a business for a sole proprietorship requires 12 different procedures across five different public agencies and private institutions. For firms it takes 40 steps involving around 10 public agencies and private institutions.77 Similarly, the Tax Code and other revenue control requirements impose a high administrative compliance burden for entrepreneurs. The Regulatory Reform Agency (OMR) in 2018 estimated that a registered business needs to maintain at least nine record- keeping books to operate. Simplified company types can support formalization. In recent years, a number of countries have been implementing legal reforms to introduce a more flexible legal form suitable to the features of MSMEs with a simplified incorporation process, the so-called “simplified corporation�, (S.A.S., “sociedades por acciones simplificadas�). Examples in the region include Argentina, Colombia, Chile, Mexico and Peru. The main objective of a simplified corporation is to provide an alternative corporate form suitable for family- owned firms, start-ups, and MSMEs. It offers greater flexibility and freedom of contract for entrepreneurs than a standard limited liability company or joint-stock company, including a streamlined registration process, where there is no mandatory requirement for third party intermediaries (e.g., lawyers, notaries, witnesses), full-fledged limited liability, optional standard articles of association, option to incorporate it electronically, and the ability to engage in multiple unrelated activities. Likewise, alternatives should be sought not only to the public deed of incorporation before notaries, but also to the legalization of corporate and accounting books before accountants or auditors. Those elements make business incorporation less costly and more accessible, particularly for MSMEs and follow “global best practices� as most have been identified as key by various organizations, such as the World Bank, United Nations Commission on International Trade Law (UNCITRAL), United Nations Conference on Trade and Development (UNCTAD), and Organization of American States (OAS).78 The OMR made a reform proposal along the same line since 2017, which has not been successfully promoted to this date. By 2020, MINEC included it within its regulatory agenda. Likewise, the Registry of Commerce participates in the inter- institutional effort to promote during 2021 the legal reforms aimed at enabling companies to be incorporated through pre-drafted forms, avoiding the need for a notary public. As for the CNR, it reports that during 2021 it plans to present a proposal for a legal reform to simplify the incorporation of companies, which shall be carried out through the use of technology such as the "Certified Electronic Signature" of the incorporating partners or shareholders. It is expected that such mechanism could be implemented during 2022. Limited impact of construction permits reforms. Since 2013, El Salvador implemented a number of reforms to streamline construction permitting. The Exports and Investment Promotion Agency of El Salvador (PROESA) launched the Integral System for Investors Attention (SIAI). In 2013, the Special Law on Agile Procedures to Incentivize Construction Projects (LEAT) was approved, which introduced legal time 76 USAID. 2018. Propuesta de Mejoras del Procedimiento de Cierre de Empresas. Economic Competitiveness Project. San Salvador: USAID. 77 https://tramites.gob.sv/menu/962?l=es. 78 The Doing Business Reports of the World Bank Group has found that in the top ten performing economies, the laws that provide for incorporation contain several of these characteristics. (Christow, 2014). 30 Business regulatory environment limits and “positive administrative silence� criteria, and created a single window.79 In 2017 the Government signed Decree № 9 to improve building quality control standards, and introduce online payment for preliminary construction fees, among others.80 According to private sector, however, the Special Law on Agile Procedures to Incentivize Construction Projects has a number of implementation challenges. The law allows builders to carry out approval procedures under the previous law and does not include all agencies involved in the process. Furthermore, the Office for the Integration of Urbanization and Construction Procedures (OIC) does not have the needed capacity nor authority to coordinate with the institutions involved. As a result, the impact of these efforts on the ground has been lagging. Currently, the Planning Office of the Metropolitan Area of San Salvador (OPAMSS) is implementing an initiative focused on the facilitation of procedures and regulatory improvement in construction permits. This initiative is part of an eight-year strategy that includes three stages. Between 2014 and 2016 (Stage 1), OPAMSS performed a reengineering of the Sub-Directorate of Urban Development, as well as an administrative simplification.81 Between 2017 and 2019 (Stage 2), it updated and improved various regulatory instruments. For Stage 3 (2019-2021), the institution is in the process of developing the virtualization of its procedures based on the design of an online form under a modalities approach.82 In addition, together with the OMR, the Secretariat of Innovation is working on a one-stop window for construction permits and procedures, which will enable the option of physical or digital procedures, where it is intended to centralize and digitize the procedures of 16 institutions. In order to provide legal support to this one-stop window, the technical team of the institutions involved is working on the design of an "Executive Decree for the creation of the One-Stop Window for construction permits and streamlining of procedures". Obtaining construction permits remains slow and costly. In spite of legal time limits, the actual time to obtain a construction permit is lengthy, 276 days according to the Regulatory Reform Agency (OMR)83 and 310 days according to Doing Business 2020. El Salvador ranks 168th out of 190 on the Doing Business dealing with construction permits indicator, which also assesses the complexity, cost and quality of the building regulations. It points to issues such as a multitude of interactions and formalities due to the lack of coordination among agencies involved, weaknesses in building supervision (e.g., inspections are not risk-based and do not always take place), and responsibility and liability regimes. During the construction of a simple building in San Salvador, builders formally have to go through 7 different inspections from 3 different agencies.84 Private sector representatives raised concerns with the redundancy of processes and documentation85, lack of clarity and excessive discretion, as well as lack of 79 Decree 521 from November 2013, “Ley Especial de Agilización de Trámites para el Fomento de Proyectos de Construcción�. The law was amended in 2018. 80 Decree № 9 amended the “Reglamento a la Ley de Desarrollo y Ordenamiento Territorial del Area Metropolitana de San Salvador y de los Municipios Aledaños con sus Anexos (RDLOTAMSS)�. 81 Stage 1 consisted mainly of the review of requirements and procedures, which contributed to the categorization of projects for the "Site Qualification and Construction Permits", as well as the implementation of the "Single Form for Preliminary Procedures" (project feasibility), and the implementation of online payments, among other actions. 82 During Stage 2, territorial planning and management instruments were updated. Likewise, in 2017 the " Steering Scheme" came into force and, as previously mentioned, the RDLOTAMSS was amended, among other actions. 83 OMR. 2017. Proceso de obtención de Permiso de Construcción. No. 2 Serie EIR–Diagnósticos. 84 Inspections are carried out by the National Water and Sewage Utility (ANDA), Office of Planning of Metropolitan Area of San Salvador (OPAMSS), and the Fire Department. 85 Agencies include OPAMSS, ANDA, the Vice-Ministry of Housing, municipalities, Ministry of the Environment, Ministry of Housing (MV), and Ministry of Culture (MC). 31 Business regulatory environment traceability of the procedures by the applicant. Dealing with construction permitting is also the second most costly in Central America (Figure 12). Figure 12: Doing Business’ performance and cost of construction permits in Central America Source: Doing Business database. Clear and easily accessible zoning rules could support more effective construction permitting and licensing more broadly. The lack of clear zoning rules generates uncertainty. In El Salvador, municipalities are responsible for formulating, tracking and executing zoning regulations. Clear, up-to- date, and easily accessible rules could help streamline procedures, such as the need to obtain a separate construction line and site qualification, and feasibility studies for water, sewage and electricity connections. Clear guidance for different types of environmental licenses is also needed.86 According to private sector interviews, zoning rules for construction purposes differ among relevant agencies including OPMASS, MARN and Municipalities. The "One-Stop Window" project for construction permits, promoted by the Ministry of Housing and supported by the Presidency of the Republic, seeks to solve this problem. This lack of clarity also impacts other sectors. For instance, the private sector raised concerns that the lack of harmonized zoning regulations across El Salvador creates excessive licensing requirements for specialized industries, such as telecommunications.87 At the subnational level municipal para-fiscal fees and taxes can vary significantly. According to Doing Business, local fees related to construction permits range from less than USD $3,300 in San Miguel up to almost USD $9,500 in San Salvador (Table 5).88 Municipal fees for registering a company can range from USD $1 in Soyapango or USD $2 in San Miguel, to USD $50 in San Salvador, while the municipality of Santa Ana does not charge at all. Some Salvadorian entrepreneurs consider that some municipal para- 86 World Bank Group. 2015. “Doing Business in Central America and the Dominican Republic 2015.� Washington, DC: World Bank Group; Doing Business 2020. 87 AmCham El Salvador. Presentation to World Bank staff on February 26, 2020 in San Salvador, El Salvador. 88 World Bank Group. 2015. “Doing Business in Central America and the Dominican Republic 2015.� Washington, DC: World Bank Group. 32 Business regulatory environment fiscal charges are not only high but may also be illegal or unconstitutional.89 As a result, there is jurisprudence through which private companies have opposed municipal tax laws, which have been put on hold by the legislative court (Sala de lo Constitutional). Table 5: Various municipal fees related to construction permits in four Salvadorian cities Procedure (Costs in USD) San Miguel San Salvador Santa Ana Soyapango Construction line and site qualification 109 725 47 409 Environmental form 40 0 20 50 Labor qualification 40 NA NA NA Water and sewage feasibility analysis 17 92 29 221 Construction permit 3,073 3,113 4,555 3,839 Final inspection NA 4,397 NA 1,483 Occupancy permit NA 1,171 469 179 Total 3,279 9,498 5,120 6,181 Source: Doing Business database. Note. Costs for San Salvador are from 2019, while for the rest of the cities from 2015. NA refers that the procedure is not required. Access to electricity has significantly improved but based on firm perceptions remains costly. El Salvador had almost universal electricity coverage by 2017, and firm surveys confirm the improvement on the ground (Figure 13). Reforms were introduced to improve the reliability of electricity and ease of obtaining a connection. As a result of continued efforts by the utility provider in San Salvador (AES El Salvador), the System Average Interruption Duration Index (SAIDI) and the System Average Interruption Frequency Index (SAIFI) considerably improved in 2016 compared to 2015. Later in 2018, AES El Salvador approved “Order ACLPR12� further streamlining the process of connecting to electricity.90 89AmCham El Salvador. Presentation to World Bank staff on February 26, 2020 in San Salvador, El Salvador. 90It introduced new internal practices to provide electricity connections. Customers can submit their electrical plans at the same time as the formal request for a connection. 33 Business regulatory environment Figure 13: Access to electricity connections (left axis) and percent of firms identifying electricity as a main obstacle in El Salvador (right axis) Source: World Bank’s World Development Indicators and Enterprise Surveys. But electricity cost remains high for many, impacting firms’ competitiveness. Nearly half of Salvadorian firms indicate that the high cost of electricity is one of the greatest barriers to growth because it increases the prices of products and services. Electricity tariffs are generally high in Central America with an average price of 21 cents (in USD) per kWh. El Salvador is the second most expensive country in the region with 24 cents, just behind Guatemala (25 cents).91 But not only tariffs are high. As measured by Doing Business, the cost of getting an electrical connection in El Salvador is 518 percent of income per capita, above the average costs for LAC (407 percent) and Central America (446 percent), and significantly higher than Panama (15 percent) or Costa Rica (158 percent). This is mainly because the customer bears the cost of installing a transformer and poles (if needed) and preparing the connection cables. Customers have the choice of paying for this investment themselves and getting in return a lower consumption tariff or asking the utility to bear the investment and paying a higher consumption tariff later on. Most customers with a load of 140kVA prefer the first option of making the initial investment in return for lower consumption tariffs.92 In sum, in part due to reform implementation gaps, the cost of operating in the formal sector remains high. Lack of clear rules and excessive discretion further increase the cost of doing business. The impact of reforms to lower the cost of starting a business and dealing with construction permits has been lagging due to implementation problems. Identifying and addressing the causes of such implementation gaps will be key to reap the benefits of these investments. Furthermore, the lack of harmonization of regulatory requirements across municipalities contributes to regulatory complexity and uncertainty. Introducing greater transparency by publishing municipal-level fees and requirements in a central database could be a first step. 91 GlobalPetrolPrices.com, from September 2019. See: https://www.globalpetrolprices.com/electricity_prices/. 92 Doing Business database. 34 Business regulatory environment 2.4. Trade facilitation Making it easier to import and export will better position El Salvador to recover from the COVID- 19 economic crisis. Firms will be looking to import and export new products and services to respond to new post-COVID demands, and there will likely be repositioning in global production networks. Local firms and FDI in El Salvador will be more competitive in this new environment if cross-border trade is fast and cheap. El Salvador performs relatively well in the Doing Business Trading Across Borders indicator, ranking 46th out of 190 economies. However, there is still room for improvement in several areas, and the government is actively working on the issue. The Ministry of Economy leads the Trade Facilitation Committee, which also integrates business representatives and together they have defined the Trade Facilitation Plan, which integrates the main issues addressed in this section. Increasing trade volumes requires efficient border crossing procedures. El Salvador operates the second largest cargo airport in Central America and two maritime ports, Acajutla and La Unión in the Pacific Ocean, operated by the National Executive Commission for Ports and Airports (CEPA). There are also high volumes of transit trade through the Pacific Mesoamerican Corridor.93 About 80 percent of land cargo transportation is goods in transit between land borders, while most exports of light manufactured goods are shipped to destination markets through the Atlantic ports in Guatemala and Honduras. At peak points, borders do not have the capacity to accommodate the flow of cargo. Customs procedures are carried out electronically, however, other border control procedures, such as inspections and other non- customs controls and procedures, the procedures are performed at border crossings, since not all border control agencies have digitalized procedures. There are frequent delays and traffic congestion at ports of entry. Pre-check points for Customs and Immigration have been installed to clear cargo and passengers before arrival at key border crossings to avoid traffic jams. Further improvements could come from pre- arrival processing, risk management, and digitalization. As part of the COVID-19 response, the Customs Administration introduced regulations to expedite imports of essential goods. In April 2020, to simplify procedures of emergency imports under COVID-19, the Customs Administration issued regulations to expedite clearance and free-up space at ports through the “Canal Azul�, a mechanism that allows expedited release of goods, subject to post clearance audits. The Customs Administration also introduced procedures for expedited shipments of essential and emergency goods, which is proving successful and could be scaled-up and made permanent. El Salvador’s trade regulations and trade facilitation rules are governed by the WTO Agreements and Central America rules. El Salvador ratified the WTO Trade Facilitation Agreement in 2014, including committing to adopting 77 percent of the trade facilitation transparency reforms in the Agreement. The country is also part of the Central American Economic Integration Framework, with a common Customs Code (CAUCA) and harmonized non-tariff technical regulations (RTCAs - Regulaciones Tecnicas Centroamericanas). CAUCA and its regulations (RECAUCA) are in the process of reform and adaptation to modern trade and technical standards. The WTO Trade Facilitation Agreement, the Central American Strategy and Competitiveness with an Emphasis on Coordinated Border Management, and the recommendations for regulations norms presented in a 2018 World Bank study are inputs for improving 93The Pacific Mesoamerican Corridor stretches from Puebla, Mexico, to Panama, covering 3,152 kilometers. It is the longest overland connection and the main trade corridor among countries in the region (OECD 2017). 35 Business regulatory environment regional instruments to achieve greater efficiency and transparency and expedite customs clearance and integration border control agencies between countries.94 El Salvador has made progress in reforming its national legal framework for trade, but regulations are dispersed and greater access to information and private sector consultations are needed. El Salvador implemented the Customs Simplification Law in 2012, which introduces the use of technologies and risk management in customs procedures.95 In 2018, time limits were established to release merchandise with four days of arrival. However, the regulatory framework is still dispersed and complex. Measures are implemented by Customs Administration Administrative Decisions published through the Ministry of Finance website. These and other relevant decisions for cross-border trade are not consistently consulted and are hard to locate. Comments on new or proposed changes to policies or laws are collected via different websites, and public consultations are not always conducted. As part of the national regulatory reform effort led by the Millennium Challenge Corporation (MCC) Compact Program, the Ministry of Finance began a regulatory improvement agenda, including the mapping of administrative procedures at Customs. The Customs Administration (DGA, Dirección General de Aduanas) is working on the issuance of a National Customs Code, to consolidate in a single instrument the different provisions that regulate customs operations and modernize the procedures for the clearance of goods pursuant to international standards, which is expected to be completed in the third quarter of 2021. It is important to continue this process by simplifying and digitalizing high frequency and high impact procedures and improving transparency and public consultations. While the Customs Administration has strengthened its ICT systems and inter-agency coordination, there is room to improve interoperability with the rest of the border control agencies. DGA operations are relatively digitalized (compared to other areas of the government), with e-signatures for customs declarations (enabled by GS4, a Mexican certifier), electronic transmission of documents, process automation, integrated electronic payments, and the most common services online. The DGA is interconnected with the Center for Import and Export Procedures run by the Central Bank (CIEX/BCR), Ministry of Agriculture (MAG), Ministry of Health (MINSAL), Police (PNC), Directorate of Antinarcotics (DAN), General Directorate of Immigration and Foreign Affairs, and Ministry of Finance (MH). The DGA is completing the migration to ASYCUDA World, a more business friendly and efficient operating system which has resulted in a significant reduction of physical inspections at borders.96 The DGA is preparing to launch an integrated risk management system, in coordination with other border control agencies. Through this system, the DGA expects to continue reducing the number of physical inspections and speed the flow of trade. As the integrated system registers trade data from other border agencies (MAG, DNM, DAN), the accuracy and effectiveness will increase. Despite the progress in reducing inspection rates, the private sector highlights that greater efforts are necessary to streamline trade at land borders with Guatemala and Honduras. . Accordingly, the Guatemala Customs Office and the Directorate General of Customs of El Salvador announced in December 2019 the implementation of the advance declaration between the two countries. The DGA also maintains electronic interconnection with SIECA and other 94 World Bank Group, 2018. Legal Gap analysis on the Uniform Customs Code of Central America and its regulations and recommendations for implementing the Trade Facilitation Agreement of the World Trade Organization and other best practices. 95 Ley de Simplificación Aduanera 96 ASYCUDA World is the Automated System for Customs Data developed by UNCTAD. As of June 2020, 55% of El Salvador customs procedures have been migrated to the system. 36 Business regulatory environment countries in the region to streamline foreign trade procedures and controls. CIEX, the Directorate General of Customs and the main border control agencies continue their efforts to interconnect with the Central American Digital Trade Platform, through which regional border control agencies interoperate to digitize procedures. SIECA anticipates that the technological developments will be developed during the second half of 2021. It is important to continue with risk management integration efforts, collaboration with neighboring border control agencies, and mutual recognition of trusted-traders programs. The airports and ports authority has also seen recent improvements. With the support of the WBG in 2017, the El Salvador Airports and Ports Authority (CEPA) simplified processes and improved its ICT systems. CEPA eliminated the re-weighing process, harmonized working hours of the agencies at the airport, and improved interconnectivity with customs to exchange information on air cargo documents. In addition, laser copies on standard office paper are now accepted for air waybills, instead of preprinted copies, which were difficult to procure. All these changes have made air cargo trade easier and faster, with significant reduction in documentary formalities and customs release times. In addition, during 2020, a public-private partnership agreement was awarded for the modernization of the airport's infrastructure, which will enable an increase in cargo handling capacity. The DGA could streamline procedures through more post-clearance audits, advance rulings, and a better trusted-traders program. Central America regional and national regulations provide for trade facilitation mechanisms, but in practice the use of these mechanisms is limited. In the past 10 years, the DGA has launched two Authorized Economic Operator programs, however these have not been successful. The current program has only two multinational companies registered. According to the private sector Commission for Trade Facilitation (CIFACIL), greater predictability, recognition from key trade partner countries, and incentives are necessary for firms to invest in a trusted trader certification. The DGA is designing a new trusted traders’ mechanism, expected to be implemented in the fourth quarter of 2020. Other tools such as post-clearance audits and advance rulings—which provide transparency and certainty on the origin, value, and classification of goods—should also be promoted. The electronic single window for imports and exports at CIEX/BCR has been significantly improved through digitization and integration of border control agencies. All export procedures operated through CIEX/BCR are digital, e.g. cargo manifestos, and import procedures are expected to be fully electronic by late 2020. Digital payments are enabled for all export and import payments.97 CIEX/ BCR has one of the government’s best ICT systems for processing, managing and storing data, and has a good track record of supporting improvements in government agencies. CIEX/BCR has the capacity to and should support a one-stop platform to publish procedures, norms and regulations on cross-border trade, and to process permits and import licenses. The implementation of health and sanitary standards could be simplified without compromising safety. Compliance with technical standards require product registration and permits to import goods such as food, beverages, cosmetics, medicines, medical devices, agro-inputs and fertilizers, among other 97 https://www.fomilenioii.gob.sv/autorizaciones-electronicas-de-importacion-para-productos-de-origen-animal-y-vegetal-se- realizan-en-linea 37 Business regulatory environment controlled goods. While the standards come from the Central American Technical Regulations (RTCAs), there is scope to improve how they are implemented in El Salvador. The preparation of documents, certifications, laboratory tests and other requirements are time-consuming increasing transaction delays and cost, some of which are passed through to consumers. The regulators of controlled goods have made progress in the digitalization of import licenses and permits for low risk food and beverages. However, product registration procedures still require physical documents and physical formalities (stamps and signatures), which are often only offered at central government offices in San Salvador. The digitalization of registration and simplification of imports through notice schemes for low risk products could effectively reduce the time and cost of document preparation and formalities while maintaining controls. This can be achieved following regional good practices such as the Mexican Commission for Protection of Sanitary Risks (COFEPRIS) advanced sanitary import notification or IVC Puertos by the National Institute for Surveillance of Food and Medicines of Colombia (INVIMA), a risk management system that enables the Agency to ensure that goods are safe for consumption at the same time as facilitating traceability and tackling smuggling. Simplified and expedited procedures for MSME exporters and importers could be introduced for all trade channels. Currently, logistics costs for small packages are up to seven times higher than in some other Central American countries (Guatemala and Panama), in part due to customs clearance procedures.98 An expedited shipment regime is only available for air cargo, effectively limiting exports and imports of small commercial packages transported by land or sea. During 2020, the Online Purchasing Facilitation Law99 came into force, which regulates courier imports for non-commercial packages, and allows a USD 200 de mínimis value threshold, under which no tariffs and import duties are applied. However, more could be done, as MSMEs do not only import samples, but also inputs and materials in smaller volumes. Requirements for consolidated cargo of imported small commercial packages could be simplified and allow for expense and cost deductions of tariffs and VAT for MSMEs. The current regulations allow for consolidated shipments of courier packages. However, businesses cannot claim taxes paid on imports because the customs declaration and VAT corresponds to the master declaration of consolidated cargo. Business that import through consolidated expedited shipments are excluded from the simplified procedure, because they require customs and tax documents. For MSMEs it is important to import rapidly and small volumes. Businesses should be able to import expedited shipments and make a customs declaration for small packages at a reasonable cost. Currently, they need to pay US$18 for each declaration for non-intrusive x-ray inspections. Customs and public and private logistics services (postal services and couriers) should work together and modernize standards, norms and procedures to provide for simplified expedited services for small commercial packages. A step in the right direction is the work of the Correos de El Salvador (national postal service) on an export service for e-commerce MSMEs. Simplified procedures for small commercial packages are important to promote entrepreneurship, MSME exports, and e-commerce, 98 Based on consultation with GENTE, El Salvador Association of Couriers, during E-Commerce Focus Group by US Department of State/ CENPROMYPE Study on the E-Commerce Eco-System in Central America. November 2019. 99 The current Law is in force until July 28, 2021, in view of this and considering the benefits generated for the users, it will be proposed that the regulation be in force permanently. 38 Business regulatory environment particularly in light of the COVID-19 crisis and related e-commerce trends. The General Directorate of El Salvador's Post Office and the General Directorate of Customs have integrated some processes that enable the processing of import shipments. It is important to incorporate interconnection mechanisms for the export of small packages through the national mail. Coordination with neighboring countries should continue to be strengthened. Central American countries are the second largest trading partner for El Salvador, after the United States. This makes coordination of customs procedures with neighboring countries essential to streamline exports of light manufacturing goods, as well as transit trade through the Mesoamerican Pacific corridor. Joint procedures will create greater efficiencies for cross-border trade. Customs administrations in the Northern Triangle are working on a harmonized scheme for mutual recognition of trusted traders, schemes to liberalize transit of goods originating in Central America, and common border standards. El Salvador should also continue efforts for greater coordination with counterparts in Guatemala and Honduras, including tax and border control authorities. Enabling the ferry route between El Salvador and Costa Rica can also help facilitate trade and avoid transit blockages in Nicaragua. El Salvador and Costa Rica initiated the short distance ferry initiative with support of the WBG and IFC in 2017. Progress has been achieved in developing the border control procedures that enable regional multimodal transportation schemes, risk management procedures, and coordinated border management between El Salvador and Costa Rica. El Salvador should continue efforts to enable suitable port operations and ensure predictability and incentives for potential investors and maritime shipping lines that will provide this service. 2.5. Property rights, institutional quality and contractual environment El Salvador presents several weaknesses in the overall quality of institutions, especially those related to contractual enforcement and security of property rights. Resolving a commercial or land dispute in El Salvador takes over 2 years.100 This is considerable, albeit shorter than in other Central American countries where it can take from 852 days in Costa Rica to 1,402 days in Guatemala. Potential causes of the delays include abuse of adjournments and lack of electronic case management systems and overall court automation. Lengthy court proceedings not only undermine investor confidence but in the context of the COVID-19 crisis pose a particular challenge given the likely increase in debt defaults. Reforming the contractual environment and enforcement inside and outside of the courts will be vital to support El Salvador’s path to recovery. Many businesses will not make it through the COVID- 19-induced recession, so enabling the surviving ones to bounce back quickly or restart will be critical. El Salvador’s judicial system compares unfavorably in the region (Figure 14). In addition to weak rule of law undermined by high crime rates, Doing Business data reveals that insolvency proceedings and resolving commercial disputes in and out of the courts are cumbersome. Where institutions ensure robust contractual rights and swift bankruptcy proceedings, it is easier for firms to reorient economic activity to meet new market demands, and for new firms to start up. 100 Doing Business 2020. 39 Business regulatory environment Figure 14: Judicial system efficiency measured by different benchmarks for Central America Source: WB’s Doing Business 2020, WEF’s Global Competitiveness Index 2019, and Heritage Foundation’s Economic Freedom Index 2020. Note: Charts refers to the scores for each international benchmark, where a higher score represents a better performance. El Salvador lacks an insolvency law. In absence of an insolvency law, insolvency procedures are regulated mainly by the Civil Procedures Code, Commerce Code, and the Mercantile Procedures Law and cases are solved through courts.101 The insolvency process is lengthy. Based on Doing Business, it takes 3.5 years for creditors to recover their credit, more than twice the OECD average. El Salvador scores 9 out of 16 points on the insolvency framework index, pointing to weaknesses in the regulatory framework itself. Currently, MINEC plans to send an insolvency bill to the Legislative Assembly during 2021. Inefficiency in the courts may be exacerbated by the “Law on Mediation, Conciliation and Arbitration� of 2009, which is outdated and not aligned with good practices.102 Although the Center for Mediation and Arbitrage from the Chamber of Commerce and Industry of El Salvador is operational, only 8 mediation cases were submitted between 2018-2019.103 The lack of a culture of alternative dispute resolution mechanisms, as well as low technical capacity of public officials, have caused delays in arbitral awards enforcement, generating distrust and low use of this alternative system. Private sector representatives also raised concerns that arbitration resolutions are not final as they can be appealed in court. An additional problem raised by the private sector is that the Investment Law (Ley de Inversiones) mandates that foreign companies from countries without trade treaties with El Salvador cannot use international arbitration, and therefore must follow arbitration in El Salvador. Arbitral awards can be appealed by the Supreme Court. As a consequence, foreign investors from countries with trade agreements with El Salvador prefer international arbitration outside the country for resolving disputes.104 101 http://www.cnj.gob.sv/images/documentos/pdf/panorama_judicial/AvancesDoctrinales/DERECHO_CONCURSAL_SALVADOREN O.pdf 102 The first law was published in 2002, but it was reformed in 2009. 103 Data from an interview from May 2020 with Danilo Rodriguez from the Board of the Center for Mediation and Arbitrage. 104 FUSADES. 2015. Diagnóstico y propuestas para el fortalecimiento del marco legal e institucional del clima de negocios en El Salvador. Estudios Estratégicos. Competitividad para el desarrollo 2015. Antiguo Cuscatlán, El Salvador: FUSADES. 40 Business regulatory environment Beyond contractual enforcement in and outside the courts, upgrading the land administration systems can strengthen property rights and increase confidence. Based on the Doing Business 2020 study, properties can be transferred within a month, compared to two months on average in Latin America, and the cost to transfer property (3.8 percent of property value) is below CA and LAC averages (4.2 percent and 5.9 percent respectively). The Registry of Real Estate and Mortgages and the Geographical and National Cadastre Institute also have a number of sound features. The Property Registry and Cadaster databases are linked, the Property Registry has online access to municipalities to check for encumbrances, and information on ownership, documentation requirements and fees is easily accessible. Nonetheless, the private sector raised concerns that the registration process continues to be semi- manual. Furthermore, geographical coverage of immovable property registry is limited, and not all privately held land is mapped (neither economy-wide nor in San Salvador) (Figure 15).105 Figure 15: Quality of Land Administration in Central America (DB 2020) Source: Doing Business database. Note. Equal access to property rights index (-2-0) was omitted since all CA economies score 0 points. There are important opportunities to improve the rule of law, property rights and the judicial system. Transferring a property is relatively efficient compared to most economies in the region, but the coverage of the property registry and cadaster can significantly improve. Resolving a commercial or land dispute is lengthy and costly. Case management systems, automation of judicial processes, prevention of excessive use of adjournments and other delay tactics, together with a modern mediation and arbitration legal framework could make dispute and debt resolution more efficient. 2.6. Suggested Business Regulatory Environment Action Plan Based on these findings, the below table presents a roadmap for improving the regulatory environment in El Salvador with estimated timeframes. The first two areas—regulatory improvement and governance and the digital agenda—are cross-cutting and impact almost all aspects of the regulatory 105Doing Business database. The Doing Business Geographic Coverage Index consists of measuring whether all private land plots are formally registered in the land registry, both for the most important city for doing business and for the country as a whole. Similarly, the Index also measures whether all private land plots are mapped, both for the most important city for doing business and for the country as a whole. 41 Business regulatory environment environment, including the cost of doing business and trade facilitation. While continuing to advance on the implementation of these broader agenda, in the short-term, the government could achieve quick and visible results by streamlining specific regulatory processes such as business registration, construction permitting, and property registration, as well as facilitating trade. These reforms facilitate firm entry, operation and exit, and thereby make it easier for businesses and the overall economy to adjust for a faster recovery and renewed growth in the context of the COVID-19 economic crisis. Given the crisis context, the government may also want to consider advancing more medium-term reforms, particularly ones focused on creating effective mechanisms for debt and dispute resolution within and outside of the judiciary to facilitate reallocation of resources across the economy. 42 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large Increase private sector involvement in policy formulation and implementation OMR; Access to Public Information Agency a) Continue promoting “Legisla� website among citizens, civil society groups and a) ST/ (IAIP); relevant line private sector organizations. continuous a) None institutions from None b) Increase the number of public consultations from agencies of the executive b) b) None executive, legislative (national and municipal), legislative and judicial branches. ST/continuous and judicial branches; Municipalities Fully implement the regulatory governance framework a) Reinforce OMR’s mandate to coordinate with government agencies the implementation of their processes and request the different agencies to designate the staff who will be responsible for the agencies' regulatory improvement process. b) Appoint members of the Elimination of Bureaucratic Barriers Tribunal. c) Accelerate the implementation of the regulatory improvement plans as Regulatory prioritized by the OMR, including relevant capacity building by the OMR a) ST governance and based on an assessment of the current capacities of priority institutions. b) ST a) None predictability in d) Finalize guidelines for administrative simplification at the national and c) ST b) None OMR; Access to Public implementing municipal levels. d) ST c) Small Information Agency laws and e) Establish coordination mechanisms between national authorities in charge of e) ST Laws, by- d) None (IAIP); Ministry of regulations the LMR’s implementation and municipalities; define regulatory improvement f) ST/MT laws, and e) Small Innovation; relevant agendas for key municipalities and sectors (e.g. construction, business g) ST/MT internal f) None line institutions from registration, solvencies, among others). h) ST/MT guidelines g) Small executive, legislative f) Fully implement the Law of Administrative Procedures (LPA), Law of Better i) MT and rulings h) Large and judicial branches; Regulation (LMR), and Law for Elimination of Bureaucratic Barriers, including j) MT i) Large Municipalities drafting and publishing relevant secondary regulation such as for the LMR. j) Small g) Initiate a systematic review of business laws and regulations at the national and municipal level and eliminate the ones lacking a legal basis. (This is part of the regulatory improvement agenda for each institution). h) Register all national and municipal procedures at the National Procedures Registry (RNT) (short-term) and ensure that the Registry is maintained on a consistent basis (medium-term) i) Operationalize Regulatory Impact Assessments (EIR) in all Executive agencies. j) Draft, approve and implement a Civil Service Law. 43 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large Implement the Digital Agenda 2020-2030 and related initiatives a) Publish annual programs for the Digital Agenda with prioritized actions and key performance indicators to monitor progress, and establish coordination mechanisms with key stakeholders. b) Speed-up the G2C digitalization process, focusing on key high volume, high frequency and high impact procedures, where procedures are streamlined. c) Implement the electronic signature in G2B and G2C public services, including the definition of central government procedures that will be required to a) ST adopt the electronic signature and the implementation of electronic signature a) None b) ST certification protocols and certification services. b) Large c) ST d) Promote adoption of electronic signature by public notaries, auditors and c) Small d) ST accountants; define key sectors and regulators that will benefit from the Secretariat of d) None e) ST/M Laws, by- adoption of e-signature. (Customs Agents, Customs Administration; Central Innovation; Ministry of e) Small Digital T laws, and Reserve Bank; CNR). Economy; SIGET; IAIP; f) None Readiness f) ST tertiary e) Undertake comprehensive review of laws, by-laws, and tertiary regulations relevant line g) None g) ST legislation that have to be harmonized with the eSignature and e-Commerce Laws (e.g. institutions h) Small h) MT Tax Code and Law of Property Transfer Tax). i) Small i) MT f) Implement the e-Commerce Law. j) Small j) ST g) Review of the impact of electronic invoicing in the reform of the Tax Code and k) Small k) MT the Commercial Code. h) Finalize the review by the Presidency and publish in the Official Gazette the Personal Data Protection Law. i) Prioritize the adoption and scale-up implementation of the electronic invoice j) Design and provide ICT and Internet educational programs and awareness campaigns to citizens and businesses, especially to micro and small firms. k) Implement regulatory policies that foster infrastructure deployment and increase allocation of radioelectric spectrum for telecommunication services. Simplify operational licenses and permits, including municipal fees a) Implement administrative simplification programs at the national and municipal levels, coordinated by the OMR, including by re-engineering Regulatory Reform Lower the cost processes, and introducing data-centric electronic systems, together with Laws, by- a) Large Agency (OMR); relevant of doing providing training to public officials. laws, and b) Small line national business in the b) Improve MiEmpresa.gob.sv by including procedures currently performed face- a) ST/MT tertiary c) Large institutions; formal sector to-face, adding workflow capabilities with established timelines and ability for b) ST legislation d) Small Municipalities applicants to track the processing and consult files; and including a document c) ST/MT repository to be accessed by all participating government agencies and d) ST municipalities. 44 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large c) Add streamlined processes of all government agencies and municipalities involved in operating licenses to MiEmpresa.gob.sv and Tramites.gob.sv. d) Provide clear guidelines and lists of national and municipal requirements by making them publicly available. Facilitate opening and closing a business a) Amend the Commercial Code to eliminate outdated requirements to open and Legislative branch; close businesses, including the elimination of the minimum capital requirement Ministries of Economy, b) Consider reforms to the Notary Law to make notarization of the opening of a) MT a) Small Finance, and Labor; companies optional b) MT b) None Social Security Institute c) Fully implement and promote the adoption of miempresa.gob.sv, and extend c) ST Laws, by- c) Small (ISSS); National Centre electronic payment options for all business registration services through a d) MT laws d) Small of Registries (CNR); single integrated payment. e) ST/MT e) Large Pension Fund d) Consider introducing a simplified company type for MSMEs. Administrators; e) Streamline procedures to close a business and improve coordination among Municipalities the agencies involved through implementation of ICT solutions, and integration of closing procedures to MiEmpresa.gob.sv Improve obtaining construction permits a) Review and, if warranted, amend the 2013 Special Law on Agile Procedures to Incentivize Construction Projects, or draft new legislation; ensure that duties of all agencies involved in projects approval are clearly defined, including ANDA (water and sewage), Ministry of Environment, Ministry of Housing, and Office of Planning of Ministry of Culture. Metropolitan Area of b) Review and update the OPAMSS regulations in line with best international San Salvador (OPAMSS) a) MT a) Small practices. and Engineering b) ST b) Small c) Strengthen the implementation of 2017 Decree No. 9 (on building quality Departments of the c) ST c) None control standards, online payment for construction fees, etc.) rest of Municipalities; d) MT Laws, by- d) Large d) Streamline construction permitting by merging procedures and developing an Fire Departments; e) MT laws e) Small online application to facilitate the processing of construction permits and Utilities companies; f) ST f) None connection to utilities; launch a single window where developers may get all Municipalities; Private g) MT g) Large government agencies’ approvals with a clearly designated government agency licensed companies in h) ST h) TBD to coordinate and manage the single window. charge of geotechnical e) Implement a risk-based approval and inspections system, and, if warranted, and topographical assess the possibility of introducing third party inspections and audits to studies strengthen agencies’ enforcement and surveillance capacities. f) Introduce joint and coordinated inspections g) Elaborate clear zoning rules and make them available to the public across the country. 45 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large h) Review taxes and fee structures and assess the feasibility of reducing fees for construction permits and occupancy permits based on a cost-recovery principle. Ease the access of electricity connections AES regional; Superintendency of a) Improve electricity utility company’s internal processes and allow for online Electricity and submission of documentation and payments. Telecommunications a) ST/MT a) Large b) Review fee structures for transformers and meters installation, external None (SIGET); OPAMSS and b) MT b) Small wiring, connection and assess the feasibility of reducing these fees based on a Engineering cost-recovery principle. Departments of the rest of Municipalities Improve domestic import/export procedures a) Consolidate publication of laws, norms and regulations in a unified and coordinated manner across border agencies, for example through CIEX/BCR. b) Maintain consistent public consultations and regulatory impact evaluations, in accordance with the regulatory improvement legal framework. c) Simplify procedures for sanitary registration and imports permits of controlled goods, following regional best practices (Mexico, Colombia). a) ST a) None d) Reinforce and continue the implementation of the integrated risk b) ST Reduce the Secretaria de Comercio b) Small management system, strengthening ICT and technical capacities of other c) ST costs and times e Innovación, Customs c) Small border control agencies (MAG, DNM, PNC, DAN) d) MT Admin of trading Administration, CIEX, d) Small e) Continue the implementation of the fully electronic single windows through e) ST procedures across borders MAG, MINSAL, DNM, e) Small CIEX/BCR and interconnectivity of Customs and border control agencies. f) MT ; protocols through trade DAN, PNC, Correos de f) Small f) Promote the use of trusted traders, advance rulings, and post clearance audits g) ST facilitation El Salvador g) Small to streamline trade flows. h) MT h) Small g) Scale-up and extend simplified procedures for MSMEs exporters and importers, including maximizing the potential of Correos de El Salvador for small packages. h) Implement digital services for border procedures and other permits through mobile phone applications to simplify user interactions. Implement regional coordination for import/export procedures a) ST Administrat a) None a) Promote coordination and joint procedures at border crossings with Ministry of Economy; b) ST ive b) Small Guatemala and Honduras border control agencies to expedite trade flows Customs c) ST procedures c) Small b) Implement mutual recognition of trusted trader schemes with Guatemala and Administration; CIEX; d) ST/MT d) regional d) Small Honduras, including developing common standards e) ST regulations e) Small 46 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large c) Extend the expedited shipments regime to include small packages transported MAG; OIRSA106, by land and sea and cargo consolidation procedures, through the reform of SIECA107 RECAUCA and national regulations. d) Ensure streamlined border procedures to promote investment of private shipping line to operate the short distance maritime route between Port La Union (ES) and Port Caldera (Costa Rica). e) Complete the revision of the Regional Customs Code Regulations (RECAUCA), to develop expedited shipments regulations that allow competitiveness of e- commerce for MSMEs. Improve property registration Immovable Property a) Improve coordination between the Property Registry and Ministry of and Mortgages a) ST a) None Finance to reduce deed registration time. Registry; National b) ST None b) Small b) Streamline registration procedures to reduce processing time. Geography and c) MT c) Large c) Fully implement the online platform for property transfers. Cadastre Institute; CNR Strengthen quality of land administration system a)Increase national geographic coverage of privately held land plots at the Immovable Property Property Registry and the Cadaster. and Mortgages a) MT a) Large b) Assess possibility that the Property Registry and Cadaster databases use the Registry; National b) ST None b) Small Property rights, same identification number for properties and ensure that they are fully Geography and c) ST c) Small institutional inter-operational. Cadastre Institute; CNR quality and c) Make statistics about immovable property transactions and number of land contractual disputes publicly available environment Promote alternative dispute resolution mechanisms a) Review and amend the Law on Mediation, Conciliation and Arbitration to introduce international good practices, as established in the UNCITRAL Judicial system and a) Small model law 2006. relevant line a) MT Laws b) Small b) Promote the use of alternative dispute resolution mechanisms for resolving institutions b) MT commercial disputes and provide training and awareness campaigns to key stakeholders. Strengthen contract enforcement Judicial system and a) ST a) Small a) Map court processes to identify sources of delays and implement an relevant line b) MT Laws b) Large electronic case management system. institutions c) ST c) Small 106 OIRSA (International Regional Body for Sanitary and Animal Health) conducts fumigation of agriculture goods at borders in El Salvador. 107 Secretariat for Central American Economic Integration. 47 Business regulatory environment Timing: Required Fiscal cost Reform Action Responsible Entity ST (<1 year), legal (ST): none, MT (>1 year) change small, large b) Invest in court infrastructure and automation of courts by allowing cases’ electronic filing and service of process, as well as online payment for court fees. c) Promote out of court enforcement Strengthen the insolvency framework a) Approve the insolvency law, as well as review existing processes for personal and MSME insolvency, particularly in light of the COVID 19 crisis. a) ST a) Small Ministry of Economy; b) Review the insolvency legal framework (including the Civil Procedures b) ST b) Small Judicial branch Code, Commerce Code, and the Mercantile Procedures Law) and, if warranted, amend it to align with the insolvency law (once it is passed) and with the international best practice. 48 Foreign Direct Investment 3. Foreign Direct Investment Foreign Direct Investment (FDI) has been a key driver of economic and job-generating growth in countries that have recorded high levels of growth. FDI has the potential to bring significant benefits for recipient countries, including enabling them to import ideas, technologies, innovation and know-how from the rest of the world. It also facilitates private investments and fosters competition and integration of domestic firms into global value chains (GVCs). Together, this can stimulate productivity improvements, knowledge transfer, and most importantly, create better and more inclusive jobs.108 According to Financial Times’ fDi markets database109, in the period 2013-2018 new FDI projects in Latin America helped create nearly 1.4 million new jobs. While El Salvador has had some limited success in attracting FDI, there is much more to be done to capitalize on FDI potential benefits. Most of the FDI received has been concentrated in a narrow number of sectors, with limited effects on the creation of sustainable growth and quality employment. Better use of strategic investment in prioritized sectors already well-established for job creation, as well as attracting new investments in additional sectors, represent good opportunities for the country to achieve greater economic growth. El Salvador could also upgrade its position in GVCs (see Chapter 6) with the help of FDI, leveraging on the strong, positive relationship between inflows of FDI and participation in GVCs.110 These opportunities also pose challenges with respect to improving the investment policy framework and the overall investment attractiveness of the country. The purpose of this chapter is to: (i) present a brief analysis of the main challenges to attract FDI and upgrade El Salvador's FDI mix; and (ii) propose recommendations on reforms that could improve FDI attraction in a post COVID-19 context, to boost the country's economic growth and create competitive jobs. The analysis begins with an assessment of FDI performance, and benchmarking against relevant peer countries in the region and the rest of the world. This is followed by a description of the challenges, potential reform areas, and a proposal for an action plan to implement key reforms. 3.1. FDI performance The following section provides an overview of El Salvador's performance in terms of FDI attraction in relation to a group of relevant peer countries.111 The country has managed to attract relatively low levels of FDI, largely in the services sector (financial, transport, telecommunications). El Salvador is beginning to have a good international positioning in the textile area and distance business services. Over the past decade, El Salvador has experienced stagnant FDI inflows in both absolute terms and relative to the size of its GDP. In the period 2010 to 2017, the country recorded the highest 108 Foreign ownership is associated with higher employment (Gong, Gorg and Maioli, 2006; Karlsson, Lundin, Sjöholm, & He, 2007) and different workforce composition (Almeida, 2003; Huttunen, 2007). 109 fDi markets database 110 World Bank (forthcoming). Global Value Chains: an Investment Perspective. 111 See Annex 4 on comparator countries selection. 49 Foreign Direct Investment percentage of FDI inflows as a percentage of GDP in 2015, with 3.5 percent of GDP; FDI flows then reduced slightly in the following years. Comparing FDI inflows as a percentage of GDP with regional, structural and aspirational peers, the country has shown weak performance over the past decade. In fact, it recorded the lowest levels of both FDI flows and FDI stocks relative to GDP among this group of nations. See Figure 16 and Figure 17. Figure 16: Foreign Direct Investment, net Figure 17: Foreign Direct Investment, net inflows, BoP current US$millions (2000 – 2019) inflows, percent of GDP (2000 – 2019) Source: World Development Indicators Source: World Development Indicators El Salvador seems to rely on few countries as a source for its FDI: in 2017 it had the least diversified FDI portfolio of the comparator countries with respect to the geographical origin of the FDI flows. According to the World Bank's bilateral FDI database, in 2017, El Salvador registered a concentration of 0.22 on the Herfindahl-Hirschman (HHI)112 index (on a scale of 0 to 1 where 0 is the best) performing below most comparator countries. Proximity to the North and Central American markets has shaped FDI inflows in El Salvador, with the United States, Panama, Colombia, Mexico and Canada being the top 5 investors, based on fDi Markets data for the period 2003-2017. Historically, FDI has also come from other countries such as Luxembourg, Spain and Costa Rica. See Figure 18 and Figure 19. 112 The Herfindahl-Hirschman Index (HHI) of geographic concentration is defined as the sum of the squares of FDI inward stock from a given country. It would take the value of 1 in the case where all FDI originates from one country and approach zero the more dispersed FDI projects are across source countries. 50 Foreign Direct Investment Figure 18: FDI source countries’ dependency vs Figure 19: Top five source countries of FDI by FDI peer countries (2017) inward stock, (2017) Source: WBG harmonized bilateral FDI database Source: WBG harmonized bilateral FDI database At the sectoral level, between 2008 and 2012 FDI inflows were similarly concentrated in both services and manufacturing industries; from 2013 to 2018 it has been mostly focused on services (65 percent). See Figure 20 and Figure 21. Figure 21: El Salvador’s Detailed Greenfield FDI Figure 20: New FDI projects ("Greenfield Announcements, (2002-2021), by economic Projects") in El Salvador (2003-2021), by sectors activity Source: Financial Times, fDi Markets. Note: Based on the total Source: Financial Times, fDi Markets number of announced Greenfield projects over the time period (through April 2021). From the point of view of economic policy and development, it is important to distinguish between different types of investment. Since not all FDI is the same, different types of investments present varying challenges and opportunities for a country like El Salvador. The ‘Investment Typology’, as pioneered by scholar John Dunning, demonstrates that different types of investment are driven by varying investor motivations (Figure 22). Natural resource-seeking investment occurs when foreign investors establish companies in the host country to access immobile natural resources, often seeking to establish production bases for export. Market-seeking investment is driven by an investor’s intention to establish 51 Foreign Direct Investment production facilities in the host economy, with the ultimate intent of supplying goods and services to the host country’s market. The 2017/18 Global Investor Survey found that most investors are market-seeking and report having multiple motivations.113 Strategic asset-seeking investment occurs when an investor seeks control of a firm- or country-specific asset, such as a brand, technologies or distribution network. Efficiency-seeking investment is export-oriented and has the potential to help El Salvador improve the productivity of its workforce and connect domestic suppliers to GVCs . This type of FDI occurs when investors seek to increase cost-efficiency of production, by taking advantage of various location-specific competitive factors, such as knowledgeable workforce, supply of key inputs, infrastructure, transport and logistics. FDI-generated exports are critical for El Salvador, as they represented 64 percent of total exports in 2017 (Figure 23). In addition, trade of intermediate and capital goods suggests that participation in GVCs represented nearly 17 percent in low-tech manufacturing exports and 78 percent in the high-tech manufacturing exports in 2017.114 Figure 22: FDI typologies and relevance for Figure 23: Exports of FDI firms in El Salvador growth/job creation (2005-2017) Source: World Bank (2018). Source: REDIBACEN, 2019 Given the mobility of efficiency-seeking investment, global competition for this type of FDI can be fierce and attracting it can be difficult. This competition can be exacerbated in a post-COVID-19 scenario where capital to invest might be scarce. Given its mobility, efficiency-seeking FDI generally relies on a strong investment climate in the host country. In fact, the 2017/18 Global Investor Survey found evidence that efficiency-seeking investors may be more responsive to policies aimed at improving the host country business environment.115 Historically, market-seeking investment has made up the bulk of El Salvador’s FDI inflows, with a very low share of efficiency-seeking investments. Figure 24 and Figure 25 below illustrate the relative shares of the main investment types between 2012 and 2016. With a share of over 80 percent, market 113 World Bank (2018). Global Investment Competitiveness Report 2017/2018: Foreign Investor Perspective and Policy Implications. 114 Red de Investigadores del Banco Central de la República de El Salvador (REDIBACEN). 2019. Caracterización y determinantes de la inversión extranjera directa en El Salvador. 115 World Bank (2018) 52 Foreign Direct Investment seeking-investment is the dominant type, driven by telecom operations. Almost 10 percent of the country’s incoming investments could be qualified as strategic asset-seeking with tourism as the dominant sector. Efficiency-seeking investments register an unusually low share of the country’s FDI portfolio. In terms of employment, FDI firms employed more than 142,000 workers, 14 percent of formal employment in 2017, paying salaries equivalent to $US 1,154 million (18 percent). According to domestic studies, efficiency-seeking investments have proven to be important generators of new jobs in the country, creating twice the average number of jobs per investment, thus providing the economy with a higher degree of added value. 116 Figure 24: Share of El Salvador´s greenfield FDI Figure 25: Share of El Salvador´s greenfield FDI by by type (2002-2016)117 type and sector (2002-2016) Source: Computation based on COMTRADE and fDi Markets data. Note: The investment typology, as pioneered by Dunning, demonstrates that different types of investments are driven by varying motivations. 3.2. Main FDI attraction challenges Entry of investors El Salvador ranks slightly below the average for middle income countries in the seven policy 118 areas to facilitate foreign investments, according to the Investment Facilitation Index.119 However, it performs better compared to peer countries, including some high-income countries in the LAC region such as Uruguay or Panama (Figure 26). The private sector consistently reports excess bureaucracy and inefficient administrative procedures as key factors that hamper investment. More details on excess bureaucracy are included in Chapter 2 on the Business Regulatory Environment. Broader investment climate issues in El Salvador that can influence foreign investment decisions include political instability, crime, tax rates, skills, infrastructure (including electricity), and others. These are outside the scope of this report, as described in the Introduction and Annex 1. While these factors influence FDI decisions, El Salvador, in the last two years, has managed to significantly reduce crime and is promoting strategic projects in the infrastructure sector, among others. 116 REDIBACEN (2019) 117 Tourism is considered FDI in search of strategic assets. 118 Transparency and Predictability, Electronic Governance, Cooperation, Application Process, Focal Point and Review, and Outward investment. 119 The index evaluates the group of countries that signed the WTO Joint Ministerial Statement on investment facilitation. As of April 2020, 69 WTO members have signed. 53 Foreign Direct Investment Figure 26: Investment Facilitation Index, El Salvador and regional peer countries 0-2 (best), (2020) Source: German Development Institute (DIE) Regulatory risk Regulatory risks also appear to have an impact on the FDI policy framework of El Salvador. While the country ranks slightly better than the region's average on FDI-related regulatory risk, it has lower performance in comparison with both structural and aspirational peers. On the other hand, the country qualifies worse than structural, aspirational and regional peers regarding the impact of foreign investment rules on businesses. The results are similar (only above Costa Rica) in terms of the protections offered to investors. See figures below. Figure 27: FDI regulatory index panel, 0-100 Figure 28: Business impact of rules on FDI 1-7 (worst), (2017) (best), (2017) Source: WBG Regulatory Risk Index Source: WEF Global Competitiveness Index 54 Foreign Direct Investment Figure 29: Strength of investor protection 0-10 As a result of regulatory (best), (2017) unpredictability investors may leave the country or decide not to execute expansion projects. These risks are more detrimental to the objectives of the country's economic policy than the potential investment disputes themselves. Twenty-five percent of developing country investors withdraw their investments or cancel their expansion plans as a result of arbitrary regulatory changes, lack of transparency, government breach of contract, expropriation measures or problems with asset repatriation Source: WEF Global Competitiveness Index and currency convertibility. This has been confirmed in the Global Investment Competitiveness Survey (GIC Survey) of 754 executives of multinational corporations investing in developing countries, where more than 25 percent of respondents had closed a subsidiary in developing countries for some of these reasons.120 Value chains and FDI – host economy linkages Underdevelopment of value chains can be a restriction on FDI and economic development in El Salvador. The country ranks worse than all regional peer countries in terms of the ability of domestic companies to absorb foreign technology. Similarly, investors perceive that local buyers lack sophistication. High rates of informality and lack of standardization partially explain these issues. See the corresponding indexes in Figure 30 and Figure 31. Figure 30: FDI and technology transfer 1-7 (best), Figure 31: Buyer sophistication 1-7 (best), (2017) (2017) Source: WEF Global Competitiveness Index Source: WEF Global Competitiveness Index In terms of supplier quality, according to GCI data El Salvador performs in line of the rest of comparators, slightly above the Dominican Republic but far from Costa Rica’s performance, the regional 120The World Bank Group (2017/2018), p. 36. Echandi (2018) on page 7 indicates that similar results were established through surveys documents in MIGA, World Investment and Political Risk Reports 2010, 2011, 2012 and 2013. 55 Foreign Direct Investment outlier. Regarding local supplier quantity, El Salvador performs slightly better than regional and structural peers and in line with aspirational peers. However, the country has a lower performance than Costa Rica and the Dominican Republic in this measure. See Figures 32 and 33. Figure 32: Local supplier quality 1-7 (best), Figure 33: Local supplier quantity 1-7 (best), (2017) (2017) Source: WEF Global Competitiveness Index Source: WEF Global Competitiveness Index As well as for other peers, these domestic supplier-related issues in El Salvador may be a reason behind the weaknesses of existing linkages between FDI firms and domestic SMEs . Weak linkages limit the benefits that FDI can bring to the rest of the country. Encouraging linkages with FDI and facilitating positive spillover effects on the national economy requires efforts in different areas and specific linking policies. 3.3. Potential reform areas The private sector is the main driver of global economic development; however, it is governments that set the environment in which companies operate. To thrive, the private sector needs a regulatory environment that creates a level playing field for businesses and investors, while providing strong investor protections. Stronger institutions have been found to reduce FDI inflow volatility in developing countries (Buchanan 2012). In the light of the 2030 Agenda, a focus on the attraction and retention of FDI is necessary but not sufficient; it is also important to focus on the qualitative contribution of FDI to sustainable economic growth that is socially fair as well as environmentally friendly. Structuring an investment policy is a complex process that encompasses multiple areas of corporate regulation managed by different government agencies. Government regulations and institutions play a decisive role in creating an enabling and predictable framework for businesses and investors, while effectively protecting consumers, public health and safety. The inherent complexity of the process, combined with the fact that governments often have a narrow window of opportunity for regulatory reform, leads to the need to undertake reforms in a coordinated manner to have maximum impact. In general, El Salvador needs to significantly increase reform efforts to improve the competitiveness of the business environment and attract and retain the necessary investments. The 56 Foreign Direct Investment country needs a comprehensive investment climate reform plan to position itself more advantageously among its regional competitors and globally. The post-COVID19 context in which the global economy will operate in the months and years to come makes this reform plan more necessary than ever before. It is worth mentioning the efforts that the government, led by the Ministry of Economy, is already making in this area. The challenge facing policy makers in this area is to find the right mix of policies to achieve national development objectives, such as creating jobs, promoting exports and integration into GVCs, or boosting productivity. Reforms targeting the following areas could help enrich FDI , encourage job creation and attract more investment in a broader set of sectors with high economic growth potential: • Legal and regulatory framework to facilitate investment; • Investment promotion, including the FDI's strategic and institutional framework; • Linkages between FDI and domestic economy; • Investment incentives; • COVID-19 related measures. Legal and regulatory framework for investment facilitation Investors rely on risk-return calculations in their investment decision-making. Legal risk and regulatory cost are usually a significant part of this equation. According to the private sector operating in El Salvador, the lack of predictability of the public agencies conduct has eroded investors’ confidence in the past. Regardless of the legitimacy of policy objectives the country is trying to pursue, the efforts towards building a perception of certainty and predictability will be essential for the country to attract the type of investment it is targeting. The document Trade and Investment Policy of El Salvador 2020- 2050121 defines lines of action and areas for improvement that are necessary and useful for focusing the government's efforts in the long term. It should be taken into account that in order to improve regulatory predictability, close coordination between authorities and strong adherence to good regulatory practices are required. (See the previous Business Regulatory Environment chapter for more details on these challenges.) Transparency and meaningful notice and comment procedures, evidence-based rulemaking, monitoring and evaluation will be required in order to sustain these actions. There is a need for a systematic and regular dialogue with investors to detect bottlenecks and common investors’ issues, with the goal of ensuring a proper aftercare that handles with these issues and having a system that advocates for solutions. One of the principal legal instruments governing FDI in El Salvador is the Investment Law (Decree No. 732 of 1999). The key objectives of the law are to promote, protect and facilitate investments in general and foreign investment in particular. Additionally, the law seeks to provide a single legal instrument for regulation of FDI in the country. In addition to the Investment Law, the Industrial Free Trade Zones and Commercialization Law, , The International Services Law, the Law on Legal Stability for Investments, the Law on Public-Private Partnerships, and other sectoral laws form the overall framework 121Document prepared by the Secretariat of Trade and Investment and published in January 2021. This document lays the foundations for a Trade and Investment Policy that enables a solid and sustained economic growth. 57 Foreign Direct Investment for FDI in the country. In addition to the domestic laws, El Salvador has signed several international agreements with treaty partners. 122 Given the evolution of good practices in investment law over the last 20 years, the 1999 Investment Law presents some room for improvement in key areas, some of these are already included in the government's proactive reform agenda, which is currently reviewing the law with the aim of improving it. Among those with room for improvement are clarifying the scope of the law to limit it to direct investments; key definitions; elimination or simplification of registration requirements with the Oficina Nacional de Inversiones (ONI); and ensuring effective access to alternative dispute resolution mechanisms such as arbitration. Recommendation The Ministry of Economy and the Secretariat of Trade and Investment are already working to put together a comprehensive matrix of issues related to investment facilitation in El Salvador, as well as in a comprehensive review of the regulatory framework for the promotion of investment and improvement of the country's business climate (including the revision of the investment law). This could be complemented by preparing a highly detailed reform action plan (objectives defined at different terms) after the matrix is completed, including the areas for improvement described above. In addition, a formal public-private dialogue mechanism should be established. Strategic framework for FDI attraction Enhancement of the strategic focus Despite the positive efforts undertaken by the current government toward elaborating a national economic development plan, there is still no clear medium- and long-term strategic vision for FDI (including its role, how to leverage existing FTAs, objectives to be achieved and contribution of FDI to economic policies). There are different levels of strategic planning and all of them must be aligned and coordinated appropriately. See Figure 34. 122El Salvador is party to several International Investment Agreements, which form an integral part of its investment legal framework. They include 24 bilateral agreements and 9 multilateral agreements. Among the 24 BITs, 13 are in force according to DGAJ data. 58 Foreign Direct Investment Figure 34: The WBG institutional framework for Investment Policy and Promotion Source: World Bank Group This strategic framework should articulate the role of foreign investment and its contribution to general policy objectives (e.g. economic growth and diversification, job creation, etc.). It should also define specific objectives for attracting investment and priority sectors, define the roles and responsibilities of various government agencies and other stakeholders in attracting investment. Lastly, it should introduce a range of clear and measurable Key Performance Indicators (KPIs) to track and monitor the progress of the implementation of the strategy, as well as evaluate its effectiveness. Following this cascading approach, El Salvador could benefit from continued development and updating of a more detailed FDI promotion strategy123 for its investment promotion agency, PROESA (Organismo Promotor de Exportaciones e Inversiones de El Salvador). The strategy could focus on attracting investment in additional sectors and niches with high growth potential and job creation, with the objective of improving its FDI performance, and diversifying its sectoral composition. PROESA has recently adopted an institutional strategy (InvestSV 124) that would begin to guide its promotional efforts. This strategy could be updated in the near future to base it on robust and adjusted value propositions, on which to set specific FDI attraction targets in a number of sectors (currently considering a total of 9 sectors) more focused to the post-pandemic economic reality. In a highly competitive environment for FDI, countries are adopting proactive and targeted investment promotion measures. Proactive investment promotion requires investment promotion agencies to go out and actively market the country’s value proposition to potential investors. Because of the scarcity of resources and the large field of potential investors, well-functioning investment promotion 123 It is worth highlighting that in January 2021 the Secretariat of Trade and Investment also launched the Trade and Investment Policy of El Salvador 2020-2050 (TIP). This policy includes among its lines of action the definition of sectoral objectives for attracting FDI. 124 InvestSV, designed in the second half of 2020, seeks to provide a roadmap that addresses the main challenges and opportunities that El Salvador's national investment promotion agency, PROESA, must face in this new global context. 59 Foreign Direct Investment agencies (IPAs) tend to take a well-defined sectoral approach. Sector prioritization that focuses investment promotion activities on sectors (5 or 6 sectors) where the country has the highest competitive advantage and highest potential to attract investors is therefore necessary. Recommendation The government might consider clarifying and detailing the role of FDI in the overarching economic development plans of the country and subsequently put together a comprehensive strategy —the recent InvestSV strategy may be a good start— based on sector level competitiveness for PROESA to implement in line with the policies promoted by the Secretariat of Trade and Investment. Any efforts carried out to design an investment promotion strategy must be based on a detailed and recent sectoral study. See Box 1 for best practices for developing investment attraction strategy. It is important that the existing FDI attraction strategies and those under preparation be adapted to the post-COVID economic landscape. This includes reviewing FDI policy and promotion plans to test which of the previous FDI target segments are resilient in a post-COVID-19 economy. Also, the identification of new emerging competitive segments that may arise from the global value chain. (See Box 6 for more details). The investment attraction strategy should also be aligned with the government’s priorities for the post-COVID-19 economy.125 In this regard, El Salvador has an important tool: the recent Trade and Investment Policy 2020-2050 contemplates the possible impacts and opportunities resulting from the COVID-19 pandemic, and reflects them in its lines of action (particularly in line of action 4.2 "Focus on attracting and retaining investments in key sectors"). Box 2: Best practices on development of investment attraction strategies Key elements for the development of a strategic framework • Articulation of the role of foreign investment and its contribution to general policy objectives, including specific objectives for the attraction of FDI; • Definition of the priorities, roles and responsibilities of major government agencies in the field of attracting, entering, retaining and promoting foreign investment chains with the national economy; • Identification of priority sectors for the attraction of investments; • Introduction of a robust monitoring and evaluation (M&E) system and mechanisms, establishing key performance indicators (KPIs) and targets for attracting and retaining investments at the macro, meso and micro level, as well as targeted profits (invested capital, created jobs, attracted technology, etc.). It should also include an Investor Monitoring System (ITS), to assess progress in relation to KPIs defined and strategic foreign investment objectives, as well as to measure the efficiency and effectiveness of public expenditures. • Establishment of a mechanism for the joint production of annual implementation plans by all implementing agencies to meet the objectives of the investment strategy, and to specify the contribution of each agency on a regular basis. A guide to developing an investment strategy An investment strategy should be developed through an advisory process with key public and private bodies and other stakeholders at both the central and regional levels. Early engagement by relevant stakeholders in 125For instance, the crisis has raised concerns in some countries about dependence on imports of some critical products and services. If this is a concern in El Salvador, PROESA (in coordination with other entities) could help promote sectors that foster resilience, such as food, pharmaceuticals and medical supplies, attracting investors that can bolster the local production of these goods. 60 Foreign Direct Investment the strategy development process is key to ensuring commitment and leveraging existing knowledge and experience. The process should be led by a designated lead agency with adequate convening power and with the capacity to manage the process and monitor stakeholder contributions. Convening power is key to ensuring stakeholder participation throughout the development process and, more importantly, to facilitate monitoring and implementation of the strategy. This is usually best achieved by anchoring the main agency near the highest level of government. At the same time, the main agency must be equipped with sufficient technical capacity to enable it to effectively design and implement the strategy-making process and coordinate contributions from different stakeholders. An investment strategy should be developed through an iterative process including stakeholder feedback and consultations to ensure adequate balance and control for optimal results. The strategy development process should build on research and inputs from public and private stakeholders to reach a strong strategic roadmap for the country. Institutional framework for FDI attraction 1) Institutional strengthening of PROESA PROESA has limited human and financial resources, hampering the implementation of its FDI attraction mandate. The agency has about 70 staff and operates with an annual budget of approximately USD 3.2 million distributed among its three departments: Export Directorate, Investment Directorate and Public-Private Partnership Directorate.. Staff numbers in PROESA are low in comparison with competing agencies in the region, as nearly half of the 70 employees are dedicated to administrative tasks. The FDI- DDI unit is formed by only 9 professionals to carry out all the unit’s activities. The WBG Global IPA survey 2020, revealed that, on average, IPAs have 38 professionals dedicated to investment promotion.126 The budget for investment promotion also seems insufficient. According to a recent World Bank study on IPAs globally, the most successful IPAs have annual budgets of at least $5 million, while most of the worst performing IPAs had budgets of around $200,000 or less.127 Research shows that countries lacking a dedicated IPA are in a weaker position to meet government objectives for attracting, establishing, retaining, expanding and linking productive private investment to the local economy. For these agencies to be successful, they need to provide relevant, focused and high-quality services to investors in different stages of their investment cycle. IPAs need to offer a comprehensive catalogue of specific services to meet relevant investor needs. From an IPA’s point of view, investor services provision goes from the proactive generation of an investment lead, to entry and establishment, to the expansion (or retention) of the project years after establishment, to the embedding of that investment to generate linkages and spillovers. An IPA should offer marketing, information, assistance, and advocacy at each of these four stages. See Figure 35. 126 The Ministry of Foreign Affairs, through the Network of Embassies and Consulates (commercial offices), assists in efforts to identify, promote and attract FDI to the country. 127 World Bank 2017 Global IPA Survey. Includes results from 80 Investment Promotion Agencies (IPAs) 61 Foreign Direct Investment Figure 35: Comprehensive Investor Services Matrix (Investment cycle stages and services categories) Source: World Bank Group Recommendations The Government of El Salvador and PROESA should review their FDI/Investment Promotion approaches and rebalance service provision to reflect significant shifts in the post-COVID FDI landscape.128 This should be done in alignment with the overall government strategy, which will likely witness a shift in the post-crisis phase. This includes a revision of the targets, segments and FDI source markets, to reflect better the new realities and challenges (e.g. increased protectionism, recent restrictive rules on FDI, shifts in the global markets, contraction of value and supply chains, greater focus on net zero ambitions and sustainable investments, emergence of new technologies such as AI, blockchain, 3D printing, Internet of Things, etc.). PROESA may want to rethink its investor targeting efforts to account for these changes. For example, there may be opportunities in positioning the country within regional rather than global value chains and attracting investors from neighboring countries. Certain investors, such as the diaspora, may have a bigger role to play, as they are more familiar with the country context and have a vested interest in the country’s development. (See Box 6 for a summary of the steps to adjust FD targeting and related policies and services during the COVID recovery phase.) Improving the quality of PROESA’s services, something that is already being worked on, will be important in the post-COVID economy, including increasing adaptability to the needs of foreign investors at all stages of the investment life cycle, with adequate FDI professionals managing a flexible portfolio reactive to the current market trends. PROESA may also benefit from collaborating with external entities and partners on services provision. Furthermore, designing an aftercare program that includes key services for established investors and a strong focus on investment retention will be required in the context of the post-pandemic recovery. Developing virtual channels for promotion, boosting digital resilience, and moving away from reliance on conferences and trade shows, are other key areas that PROESA and other government agencies could strengthen to target and assist investors remotely. This could include fast-tracking the adoption of technologies, tools, and skills that can help the IPA operate virtually, e.g., upgrading or introducing video conferencing, collaboration tools, social media, cloud-based CRMs). 128It is worth highlighting PROESA's efforts in providing individualized monitoring of strategic projects and offering them key services during the pandemic. 62 Foreign Direct Investment PROESA could aim to become a best practice reference agency in the region.129 Improving the current situation in the short term would not require much structural change within PROESA, as the required functions already exist in one form or another. The investment attraction functions could be significantly strengthened, and hosting separate functions such as PPPs could be re-evaluated. Box 7 and Box 8 describe examples of good practice investment promotion agencies from India and Malaysia. 2) Institutional coordination for FDI promotion El Salvador is working to strengthen the coordination of national investment promotion efforts, since several government agencies are simultaneously working on investment attraction-related issues. These include the Secretaría de Comercio e Inversion, the Ministry of Economy, PROESA, and even the Foreign Affairs Ministry. Among these parallel initiatives, PROESAS’s relatively small investment attraction team might find it difficult to position PROESA within the national overall institutional framework for investment promotion. The following table details some key points to improve inter-institutional coordination among key stakeholders. Box 3: Key Principles for Effective FDI Institutional Arrangements • Strong alignment across government that stems from a clear national development plan or objective, vision, or strategy—including FDI—with clear priorities and sequencing; • Government support for FDI promotion from the highest level (for example, the president or prime minister) that directly or indirectly champions the needed policy, legal, regulatory, and institutional reforms; • Systematic and reform-oriented consultation with the private sector; • A strong, clear, and uncontested mandate for each institution that also stems from the national development objectives and avoids any possible conflicts of interest; • Sufficient and sustained financial and human resources to properly deliver the mandate of each agency; • A clear focus on results management; and • Strong partnerships and coordination mechanisms with both public and private sectors at both national and subnational levels to ensure consistency between institutions. Recommendations The government could continue to strengthen its FDI attraction framework through the formalization and institutionalization of a specific coordination mechanism for the attraction of investments that will ensure efficient and effective use of resources available for proactive investment promotion. This formal mechanism would favor dialogue and exchange of ideas among key actors with a role to play in the area of FDI promotion. An effective effort coordination mechanism has, among others, the following characteristics: • Shared investment promotion strategies and goals to contextualize and frame the coordination effort (that is, coordination toward the attraction of more high-value-added market-seeking and efficiency-seeking investment); • A collaborative design process of promotional plans to deliver coherent and comprehensive messages to potential investors; 129It would be interesting to consider establishing alliances with countries with successful IPAs to transfer knowledge and best practices in attracting FDI. 63 Foreign Direct Investment • An effective communication system in place to facilitate information sharing between the different actors (for example, online shared platforms, periodic meetings, shared investor relationship management systems, and so on); • An efficient organizational structure (a steering committee, working groups, joint missions, etc.) Linkages and Stimulation of GVC participation The existence of links between FDI and the local economy, as well as its positive impact, depend on many intermediate factors. Factors include the absorption capacity of local industry, the availability of skilled labor, a good business environment with, for example, effective implementation of contracts that encourage foreign-invested enterprises to enter into an agreement with local suppliers, the level of formality of the economy, and the availability of information. In other words, the country has a long agenda of potential reforms to stimulate FDI linkage and spillovers. There is a lack of coordinated interagency mechanisms between PROESA, CONAMYPE and other SME-related bodies to promote linkages between domestic firms and multinational corporations (MNCs) for inclusion in GVCs. The government can play an important role in adopting policies to stimulate GVC participation. Recent WBG research130 has found five approaches (covering different GVC archetypes) that governments have successfully deployed to use investment to integrate into GVCs: 1. Use training to help domestic firms meet the product standards of foreign firms; (Kenya – Horticulture) 2. Develop location-based enabling environments for FDI (e.g. using Special Economic Zones); 3. Use existing economic clusters to move into higher-value GVCs; 4. Target global lead firms, and link them to the domestic economy; 5. Develop “homegrown� GVCs using outward FDI. Recommendations Assess the status of linkages and subsequently design and develop a linkages program El Salvador would benefit from first conducting a demand-supply assessment of existing linkages between domestic and FDI firms. The assessment would illuminate the needs and potential for increasing local inputs and services of key players in strategic sectors. Based on the assessment, the government could develop a program to strengthen FDI-local linkages. Among other things, linking foreign companies with local suppliers could render both more resilient to shocks that disrupt supply chains. Box 4 provides examples initiatives to foster linkages between FDI and local suppliers from Vietnam, the Czech Republic, and Costa Rica. 130 World Bank (forthcoming). Global Value Chains: an Investment Perspective. 64 Foreign Direct Investment Box 4: International good practice examples on FDI-supplier linkages program: Vietnam, Czech Republic and Costa Rica Vietnam is endeavoring to attract a “second generation of FDI�, complement ed by efforts to link local firms to the existing FDI stock and foster participation in regional value chains. The World Bank Group is supporting the government through a market-based linkages strategy to better connect local firms to MNEs in sectors with a critical mass of FDI (e.g. apparel, electronics, automotive). The initiative includes investment policy interventions for improved market entry for investors, improving alignment of institutional roles and capacities, and the design of a tailored linkages, incentives and supplier development program. The implementation of a linkages program like that of Vietnam requires governments to have a deep understanding of the opportunities for backward linkages, and it was designed after conducting a demand-supply gap analysis. Once demand and supply needs and gaps are properly identified, it is key to have a comprehensive and updated database to maximize linkages opportunities. CzechInvest’s (Czech Republic IPA) database of local suppliers is the central tool used by its Sourcing Department (which measures its performance by the value of contracts facilitated) to promote linkages. It contains more than 3,500 high-quality records of Czech suppliers interested in long-term cooperation with foreign partners. Contracts concluded between Czech suppliers and MNEs between 2001 and 2011 amounted to USD 586 million. In Costa Rica, CINDE (national IPA) reports that its directory of local suppliers has also been a key component in helping companies start operating in Costa Rica. In 2015, CINDE attracted a total of 39 new projects in the services, advanced manufacturing, life sciences, light manufacturing and food industry sectors. Each of the new investors made use of the directory of service providers during their scoping and establishment phases. Incentives El Salvador, as many other economies in the region, offers generous incentives programs to attract FDI. Several laws contribute to the promotion and protection of investments, including: • The Industrial Free Trade Zones and Commercialization Law includes fiscal incentives to foreign and domestic companies on several agricultural, manufacturing and agricultural segments which are operating in these zones.131 These companies must export internationally. It includes exemptions on income tax, fuel tax, custom duties on commodities and equipment, and land/real estate purchase and transfers. 132 • The purpose of the International Services Law, according to its article number one, is to regulate the establishment and operation of service parks and centers, as well as the benefits and responsibilities of the owners of firms that develop, manage or operate in them. It offers tax incentives to services providers for foreign clients. It incentivizes activities such as call centers, logistics, BPOs, ICT, media and financial services, among others. It includes tax exemptions for imports of technical equipment and total exemption of municipal and income taxes.133 • The Tourism Law states that, with a minimum investment of USD 25,000, a company may qualify to be declared a tourism project of national interest and qualify for benefits such as 5-year partial 131 The Law of Industrial Free Trade Zones and Commercialization (1998). Decree No. 405. Legislative Assembly - Republic of El Salvador. The purpose of the Law is: "to regulate the operation of Free Trade Zones and Deposits for Active Improvement, as well as the benefits and responsibilities of the owners of firms that develop, manage or use the same." (Article 1). 132 The complete list of incentives, as well as the reasons for their suspension, may be consulted in Articles 17 and 19 of the Law. 133 LEY 2007 DE SERVICIOS INTERNACIONALES. DECRETO No. 431. ASAMBLEA LEGISLATIVA - REPUBLICA DE EL SALVADOR 65 Foreign Direct Investment exemption of municipal taxes, 10-year total tax exemption of real estate purchases or transfers and income tax, and exemptions from import duties.134 • The Fiscal Incentives Law for Promotion of Renewable Energies is intended to stimulate private investment in projects that use renewable energy sources, such as hydro, geothermal, wind, solar, marine, biogas and biomass. It includes a 10-year tax exemption for imports of equipment and revenues from energy generation.135 However, the Government, although some efforts along these lines have been initiated recently, historically, has not systematically assessed the cost-effectiveness of incentives in achieving targeted policy objectives, and there is no specific and centralized inventory of the incentives available for investors at a national level (it is important to note that the Investor's Guide available on PROESA's website includes very relevant information on available incentives and is a clear step forward in this regard136). A survey of FDI firms in El Salvador revealed that tax incentives are considered a major determinant of investment, especially for efficiency-seeking firms.137 Nevertheless, without a cost- benefit analysis it is not possible to gauge how effective incentives policies are and improve their targeting. Tracking the effectiveness of incentives in creating growth and jobs will become even more important in a post-COVID-19 context with reduced fiscal space. The below WBG three-step framework identifies good practices for the design of sectoral incentives. Figure 36: Good practices for the design of investment incentives Source: World Bank From an investment promotion perspective, different types of FDI can respond differently to the overall investment climate as well as tax and financial incentives . Efficiency seeking investors— whose investment decisions are primarily driven by saving costs—are more likely to be responsive to tax 134 LEY 2005 DE TURISMO. DECRETO No. 899. ASAMBLEA LEGISLATIVA - REPUBLICA DE EL SALVADOR 135 LEY 2015 DE INCENTIVOS FISCALES PARA EL FOMENTO DE LAS ENERG�AS RENOVABLES EN LA GENERACIÓN DE ELECTRICIDAD. DECRETO No. 462. ASAMBLEA LEGISLATIVA - REPUBLICA DE EL SALVADOR 136 https://investelsalvador.com/3d-flip-book/investors-guide/ 137 REDIBACEN (2019). 66 Foreign Direct Investment and financial incentives. However, such investors also tend to be very demanding regarding the general investment climate and the ability to connect with global markets. Thus, incentives are more effective when embedded into an overall investment promotion strategy with the aim to improve the investment climate and make it more attractive for foreign investors. Box 5: International Good Practices on Incentives’ Governance and Design 1. Simplicity and access to information: The incentives regime should be simple, and information provided in a user-friendly and accessible format. 2. Streamlined procedures and minimal discretion: The process for applying for and granting investment incentives should be simple and minimize discretion. In the case of tax incentives, the approval process should be automatic (with verification). 3. Consolidation of tax incentives in law: Tax incentives should be clearly laid out in the relevant law, ideally the Tax Law, and should not be negotiated on a case by case basis. 4. Regular assessment of fiscal cost: The fiscal cost of incentives should be systematically tracked and published, including through tax expenditures. 5. Consistency with international investment regimes and minimizing distortions to competition: Incentives should be designed in a way that minimize distortions to competition and follow international investment regimes. 6. Defining policy objectives: Incentives should be linked to clearly defined policy objectives and instruments tailored based on these. 7. Targeting the marginal investor: To optimize benefits, incentives should be precisely targeted, focusing on marginal investors (those who would not have invested had it not been for the incentive). In the context of incentives used to attract FDI (locational incentives), incentives targeting efficiency-seeking investment should be prioritized. 8. Monitoring & Evaluation: Monitoring and evaluation mechanisms should be in place to verify whether the policy objective of incentives is accomplished and to evaluate the cost-effectiveness. Recommendations: Compile an updated comprehensive incentives inventory listing core program information on incentives programs at all government levels. Such an inventory would allow for increased transparency and clarity, both for the government, as well as investors. The inventory should list all incentives offered and the corresponding information on eligibility criteria, nature of benefits, legal sources, application processes, etc. The Secretariat of Trade and Investment could play a role in the digitization of information related to incentives. In line with the governmental efforts already undertaken, analyze and evaluate the effectiveness of existing incentives and redesign if necessary (including non-fiscal incentives). The analysis could cover the cost in terms of foregone revenue of the existing investment incentives and their effectiveness. Possible areas for reform include the targeting of incentives, selection of appropriate instruments (including behavioral and non-fiscal incentives), design of and implementation of a cost- benefit M&E system, and improvement of administrative practices. Consultations could also be undertaken with key stakeholders to determine whether existing incentives are appropriate given the current economic context or they could be limited to strategic sectors. Revising existing incentives and creating new schemes will be important in the context of the economic recovery process post COVID-19 given that some sectors and investors will be more affected than others. 67 Foreign Direct Investment Additional post-COVID-19 measures and recommendations The COVID-19 crisis is bringing about unprecedented disruptions to the global economy, largely due to the strict policy measures introduced by governments worldwide to suppress the spread of the pandemic. Investment flows across the globe are expected to decrease drastically: UNCTAD estimates a 40 percent decline in global FDI in 2020.138 The ILO estimates that almost 25 million jobs could be lost worldwide as a result of COVID-19139, threatening to increase poverty levels. A recent WBG survey of IPAs140 also reveals that foreign investors, especially in the services sector, are experiencing impacts in areas such as employments, productivity, sales and revenues/net income.141 Immediate activities to respond to the pandemic include shifting focus towards retention of strategic and anchor investors through emergency aftercare and retention programs. This includes: • Tracking and monitoring the risk and impact on investors; • Managing issues and grievances via direct assistance; • Undertaking policy advocacy. For the recovery phase, FDI-related strategies and services should be adapted to attract value- adding investments in the post-COVID economic reality, as described in Box 6. It is difficult to predict what this reality will look like; however, some trends are expected or starting to manifest. The Economist magazine expects three trends to accelerate: the adoption of new technologies, a retreat from expansive global supply chains, and a rise in well-connected oligopolies.142 Most relevant for IPAs and FDI is a possible “retreat� from globalization, with businesses giving greater priority to supply-chain resilience over the current focus on efficiency, the development of regional value chains, and a push for on-shoring or near-shoring. These disrupting factors may compel investors to review investment locations. Taking these into consideration, the following are suggested for the crisis recovery phase (in addition to measures in Box 6): • Utilize initial investor experiences and testimonies: Bringing in initial FDI immediately at the end of the pandemic gives a positive signal and crowds in further investments. Therefore, investment promotion and investment climate reform activities have to continue and/or start early. • Focus on image building. Communicate an image of the government’s promptness and effectiveness in dealing with the outbreak, as well as its commitment to economic reform and investor retention and facilitation. 138 https://unctad.org/en/PublicationsLibrary/diaeiainf2020d3_en.pdf 139 http://www.ilo.org/global/about-the-ilo/newsroom/news/WCMS_738742/lang--en/index.htm 140 World Bank (2020e). Initial Response of Investment Promotion Agencies to COVID-19 and some Observed Effects on Foreign Direct Investment. 141 Foreign Investor Confidence Pulse Survey: First Round Results April 2020, Investment Climate Unit, World Bank, Washington, DC. 142 https://www.economist.com/leaders/2020/04/08/the-coronavirus-crisis-will-change-the-world-of-commerce 68 Foreign Direct Investment Box 6: Sequence for adjusting FDI-related policies and services for recovery from the COVID-19 crisis 1. Review FDI policy and promotion strategies to test which of the previous FDI target segments are resilient in a post-COVID-19 economy. This requires assessing the exposure of segments where the government was actively pursuing investor outreach pre-Covid-19, to test if their value propositions remain strong. Reviewing includes identifying emerging competitive segments that may arise from the global value chain/FDI footprint remapping. 2. Confirm new priority segments with ministries and agencies responsible for business registration and operations, including entry regimes, licenses, work permits, incentives administration, etc. Coordinate with these entities to prioritize reforms that could support the new segments. 3. Implement reforms to improve the value propositions for current and emerging priority segments. This may require, inter alia, aligning the incentive regimes with the new target segments and reviewing the legal and administrative framework. 4. Promote the new segments, with PROESA undertaking investor outreach and facilitating investments in the new segments. PROESA’s facilitation role, especially in articulating new opportunities to investors, should grow. Box 7: International good practice example: high performing investment promotion agency—Invest India Invest India illustrates how a new investment promotion agency can be built up over just a few years by following key principles and avoiding typical mistakes. Invest India was established in 2009 as a joint venture of the Department of Industrial Policy and Promotion of the Ministry of Commerce and Industry, the Federation of Indian Chambers of Commerce and Industry, and state governments of India. The agency lay dormant for many years and, even as recently as 2015, had no more than a handful of staff reactively answering investor queries, with little or no traction with potential foreign investors. In September 2014, Prime Minister Narendra Modi launched “Make in India,� a Government initiative to persuade and encourage companies globally to manufacture their products in India (www.makeinindia.com). As part of this initiative, the government decided in 2015 to reinvigorate “Invest India,� recognizing the need f or a government agency to proactively tackle the attraction of foreign firms. Invest India was mandated to ramp up its investment promotion efforts and capitalize on the potential of India’s economy. Following international good practices, Invest India: - Received the full support of senior-level government officials. A new chief executive officer was appointed and given direct access to the key ministers and the prime minister’s office. - Set its goals linked to the country’s broader development goals. - Was officially mandated to lead the country’s national investment promotion as the single point of contact for foreign investors. - Was not assigned any regulatory functions. - Was given sound financial support from the Department for Promotion of Industry and Internal Trade and a functioning board with 51 percent private sector representation. - Was permitted to adopt a much flatter organizational structure than typical Indian civil service entities and to recruit high-caliber management and staff outside the normal civil service recruitment procedures. - Adopted a consultancy-like operating model designed to offer quality services to investors. - Shifted into a dynamic, service-oriented organization with highly qualified staff. As of mid-2019, 51 percent of the staff were women. Since the agency’s rejuvenation in 2015, Invest India has been transformed into an award -winning IPA, contributing to making India one of the world’s top-five greenfield destinations in 2018. Invest India received 69 Foreign Direct Investment the UNCTAD global award for best-practice IPA in 2016 and for sustainable development investments in 2019. It was also named best IPA in South Asia, East Asia, and Oceania at Dubai’s Annual Investment Meeting (AIM) in 2016, 2017, 2018, and 2019, and was elected as co-vice president of WAIPA for 2019–20. By mid-2019, Invest India had responded to more than 193,000 business requests from 126 countries and 41 sectors, 92 percent of which were answered within 72 hours. Working with some 760 companies, it had generated a project pipeline of US$138 billion, of which an estimated US$22.7 billion had been executed, with 135,000 direct jobs in the process of being created. Sources: Invest India website: www.investindia.gov.in; interviews with Invest India top management. Box 8: International good practice example: high performing investment promotion agency— Malaysian Investment Development Authority (MIDA) Malaysia’s national Economic Transformation Program had as its main goal to ethe country into “a high-income nation by 2020� through clarity of vision and prioritization of economic sectors to deliver a coordinated policy agenda. Success in electronics, started in the 1970’s with a strong focus on attracting assembly of simple components (e.g. printed circuit boards and manufacture of basic consumer products like black-and-white televisions). Building on this success, Malaysia sought a structural shift to key sectors and defined a long list of priority sectors based on an algorithm of sector income, historical growth rates, and potential growth rates. The top sectors ranked by GNI were selected as priority sectors. The determination at the top of the Government of Malaysia about the importance of FDI and industrialization was critical to recast investment promotion efforts, with MIDA at the center of these, and several drivers were key to generate success on this strategy: - Transformation of MIDA into a professional IPA with streamlined mandates. - Set up a new institutional framework and public-private board of directors, including representatives from key government agencies (e.g. Labor, Environment, ICT departments, Customs, etc.). - Shifted focus to attract FDI in a few competitive sectors. - Developed a new investor service offering. - Staff with public and private sector experience. - Designed a well-coordinated institutional framework with public and private sector participation. - Defined new functions and KPIs. According to UNCTAD, FDI inflows represented 45 percent of Malaysia’s GDP in 2017, totaling $9.5 billion (WIR 2018). This is an increase of 55 percent since 2010. Sources: MIDA Malaysia website: www.mida.gov.my; interviews with MIDA top management. 70 Foreign Direct Investment 3.4. FDI Action Plan Fiscal Timing: cost ST (<1 Required Responsible (ST): Reform Action year), legal Entity none, MT (>1 change small, year) large Design/update a strategic plan that articulates the Ministry of role of FDI, defines objectives, targets, contribution Economy to policy goals, clarifies the roles of key agencies, and PROESA ST None Small introduces a robust M&E framework. This should be Secretaria de done in consultation with key public and private Comercio e stakeholders. Inversiones Strategic Continue working on the update of the sector- framework for focused investment promotion strategy (InvestSV) for FDI attraction PROESA. It should be based on a very robust sectoral PROESA, evaluation that identifies a set of priority sectors MINECO, ready for targeted investment promotion based on Secretaria de ST None Small current competitiveness. The estimated resilience of Comercio e sectors in a post-COVID economy should be Inversiones considered, as should emerging competitive sectors that may arise from the GVC/FDI footprint remapping. Assess areas for improvement in PROESA and By-law undertake necessary institutional strengthening, e.g. changes PROESA ST Small functions, financial resources, staff training, provision might be of investor services, M&E. needed Shift focus to improved aftercare and advocacy activities undertaken during and after the pandemic to ease companies’ return to normal activity, by Institutional designing an aftercare program that includes key PROESA ST None Small Framework for services for established investors and a strong focus FDI attraction on investment retention, following up until reforms are achieved. Boost digital capabilities by adopting remote and Small to increasingly digital means of communication and PROESA ST None medium tools. PROESA, By-law Strengthen and formalize inter-institutional Secretariat of changes ST Small coordination mechanisms for investment promotion. Trade and might be Investment needed 71 Foreign Direct Investment Based on the outcome of the barriers mapping exercise, the government should consider removing identified restrictions to the extent needed to achieve the policy objectives pursued and facilitate investments. Work could also be continued143 in the following areas of the Investment Law currently under review: Legal and • Clarify the scope of the Investment Law to limit By-law regulatory it to direct investments; Ministry of changes Small to framework for ST • Map sector entry restrictions that are not Economy might be medium investment currently included in Article 7; needed facilitation • Eliminate or simplify registration requirements with the ONI; • Expand expropriation protection to cover both direct and indirect expropriation; • Ensure effective access to alternative dispute resolution mechanisms. Conduct a demand-supply assessment to understand the potential to increase linkages between domestic Ministry of Linkages and and FDI firms. Subject to the results of the Economy, ST None Small Stimulation of assessment, design and implement an FDI linkages PROESA GVC program. participation Ministry of Devise programs to foster linkages between FDI and Small to Economy, MT None the local economy. medium PROESA Evaluate the effectiveness of existing incentives via Secretaria de By-law cost-benefit analyses and qualitative assessments. Comercio e changes Small to ST Redesign and/or replace with lower fiscal cost Inversiones might be medium instruments if necessary. PROESA needed Incentives Secretariat of Trade and Investment Create an online centralized incentives inventory. ST None Small PROESA, Ministry of Economy Collect successful investor experiences and PROESA ST None Small Additional testimonies to be disseminated via media. Post-COVID19 measures Focus on image building and highlighting the efficiency of the Government’s response to the crisis PROESA ST None Small and the economic viability of investing in El Salvador. 143 The Government has made significant progress in the elaboration of a new draft law that will add substantive improvements in key areas related to investment facilitation and protection. 72 Access to Finance 4. Access to Productive Finance Financial products are necessary to reduce costs, minimize risks, manage the impact of crises, increase capacity, and support the viability of firms. The financial sector plays an important enabling role for the productive sector given its function as intermediator of resources. However, new, micro and small firms primarily, face important constraints to access available financial resources due to informational asymmetries, high interest rates, lack of collateral (real estate or land), inability to use the collateral they possess (movables) as a result of inadequate frameworks, or a limited product offering. For these reasons the implementation of policies and actions and the development of adequate frameworks can improve the lending and financial ecosystem and have a positive effect on MSMEs. The size of the business positively correlates with its access to credit. Smaller enterprises have greater restrictions on access to credit. Only 30 percent of small firms report having a bank loan or a line of credit versus 61 percent of medium and 79 percent of large firms, which hinders the capacity of smaller firms to finance working capital and investment though the financial sector. These recurring challenges are being augmented by the unprecedented COVID-19 crisis. As the effects of social distancing due to COVID-19 reduce demand for their products and services, firms, particularly smaller firms, will become increasingly cash constrained, reducing their creditworthiness. A protracted shock in aggregate demand on the real economy will require firms to withdraw cash and decrease their ability to service their debt. In the absence of income, firms will not be able to cover their financial obligations, tightening financial market liquidity. The impact to the financial sector seems to be contained in the short term given that, the current levels of liquidity in the banking sector are abundant, capitalization and provisioning are adequate, and the levels of non-performing loans (NPLs) are low. However, second round effects could tighten the liquidity conditions of deposit-taking financial institutions and affect the overall solvency144 of the financial sector, thus creating an amplifying effect on the economy. The ultimate objective of a well-developed, deep and efficient financial sector, in general, is to intermediate financial resources for their optimal use. The financial system mobilizes deposits, enables payments, provides mechanisms for collections, and facilitates the needed funding for working capital to firms. The financial sector can also play an important role to responsibly and sustainably mitigate the effects of the containment measures implemented to reduce the impact on public health caused by the global pandemic. This role is essential to limit the damage to viable businesses, their workers, and the entire economy. However, the procyclical nature of the financial system could have devastating economic consequences if financial sector interventions threaten its stability. Therefore, careful analysis of financial sector emergency response measures is necessary. 144The BCR has issued a series of Technical Standards, including NRP-25 for the gradual application of the provisioning of loan loss reserves affected by COVID-19, which would moderate the impact on banks' solvency: https://www.bcr.gob.sv/regulaciones/upload/NRP-25.pdf?v=1619544345. 73 Access to Finance 4.1. The financial sector in El Salvador: structure and performance The Salvadorian financial sector is comparable in size to its regional peers and has been steadily expanding in the last five years. Most recent financial sector performance data, which does not capture the immediate impact of the COVID-19 crisis, suggests that the financial sector in El Salvador will be able to weather a relatively short-lived crisis. The banking sector appears solid with low levels of NPLs (1.68 percent as of the last quarter of 2020; a reduction of 0.12 percent year-over-year145), properly capitalized (the regulatory capital-to-risk weighted assets ratio stood at 15.4 percent as of May 2020) and adequately provisioned (provisions to NPLs as of the end of 2018 equaled 129 percent)146. The financial sector is also highly liquid. While credit to the private sector expanded by 6.4 percent year-over-year (Figure 2) driven by lending growth to the manufacturing sector (credit-to-GDP stood at 52.4 percent), real deposits, fueled by a surge in deposits from remittance flows, increased 12 percent. The loan to deposits ratio stood at 92.1 percent at June 2020; however, the maturity profile of loans shifted towards the short term (between 2018 to 2019).147 Also, the ratio of liquid assets to total assets stood at 23 percent (Figure 37). However, dollarization limits the capacity of the BCR to inject liquidity in cases of emergency, which warrants heightened financial sector surveillance and calls for strengthening the Emergency Liquidity Assistance (ELA) framework, including the introduction of a Liquidity Fund. Figure 37: Private Credit to GDP in El Salvador Real Credit Growth (% YoY) Private Credit to GDP (%) Source: Haver Analytics (Quarterly Data) Source: WB FinStats 2020 (IMF IFS) 145 The quality of the banking portfolio may be affected by contingency measures applied to face the COVID-19 crisis, such as restructurings, refinancing, moratoriums, both in El Salvador and in the rest of the world's financial systems. 146 Sources of Data: Haver Analytics, IMF International Financial Statistics (IFS) & Financial Soundness Indicators (FSI), and World Bank FinStats. 147 Idem. 74 Access to Finance Loans to Deposits Ratio (2019-Q4 or latest) Liquid Assets to Total Assets (2019-Q4 or latest) Source: Haver Analytics (Quarterly Data) Source: Haver Analytics (Quarterly Data) However, low lending to deposit interest rate spreads (1.5 percentage points) have compressed banking profitability. These indicators remain among the lowest in the region with a return on assets at 1.1 percent (below an average of 1.4 percent in Central America and 2.1 percent in Latin America) and return on equity at 9.1 percent (below an average of 12.2 percent in Central America and 17 percent in Latin America).148 This poses an important strain on the sector considering a set of first stage impacts due to the economic slowdown beginning with lower bank loan growth, reduced fee income, and, in a second round, higher loan delinquency. The financial system in El Salvador remains banking centric and dominated by global and regional financial groups. After a decade-long process of mergers and acquisitions, the banking sector is currently comprised of 11 private commercial banks, two public first-tier domestic banks and one public development bank (with first and second floor operations). El Salvador has the largest presence of foreign ownership among the Central American countries. Foreign owned banks account for 89 percent of the banking system, in terms of total assets.149 Concentration is also relatively high. The three largest banks account for 73 percent of total assets, above the regional median of 63 percent. Credit allocation is biased towards consumption and much less towards productive activities. Consumption represents 35 percent of total lending followed by housing (19 percent) and commerce (13 percent).150 There are numerous non-bank financial intermediaries (NBFIs) in El Salvador. Some of these are regulated by the Central Reserve Bank (BCR) and supervised by the Superintendence of the Financial System (SSF). There are 22 insurers and two pension administrators, a stock exchange, and other institutions authorized to take deposits, including two cooperative banks, four workers’ banks (banco de los trabajadores) and four savings and credit companies (SACs) in El Salvador. Payment service institutions include 14 transfer companies and one recently authorized electronic money provider, TIGO Money. The offer of non-banking financial savings and credit serving households and smaller firms is extensive, fragmented, and mostly unregulated. The Non-Bank Savings and Credit Institutions (NBSCIs) 148 Idem. 149 Source: IMF Country Report No. 20/106 150 Source: Author’s calculations based on public information from Superintendencia del Sistema Financiero (SSF). 75 Access to Finance include: four SACs (all of which are regulated by the BCR Standards Committee), Savings and Loans Cooperative Banks151 (which include four workers’ banks totaling six regulated institutions), three federations (of which only one, FEDECREDITO, is regulated), Credit Unions, non-governmental organizations (NGOs), and factoring firms, for a total of approximately 600 providers. FEDECREDITO, and the other two unregulated Federations, FEDECACES and FEDECRECE, provide different services such as representation, technical assistance, and self-regulation to its members. The number and size of cooperatives that remain outside of the scope of regulation and supervision has been a subject of numerous discussions with the aim of introducing some of them within the regulatory perimeter and establishing a regulatory and supervisory framework proportional to their risks. The Legislative Assembly has received regulatory proposals in the past from the BCR, SSF, and other unions to strengthen regulation and supervision; however, no progress has been recorded. The Salvadoran Institute for Cooperative Development (INSAFOCOOP) is a specialized autonomous institution entrusted to promote, organize, supervise and regulate cooperatives. As of the end of 2019, there were 1,301 cooperatives registered with INSAFOCOOP, 578 (44 percent) of which are Savings and Loans Cooperatives.152 INSAFOCOOP has limited capacity (17 auditors and 18 people for promotion of the sector), it does not provide prudential supervision and its activities are limited to registration, information, legal and technical advice. The four regulated SACs and nine NGOs are affiliated to the Association of Microfinance Institutions (ASOMI). In terms of size, it is estimated that one third of the assets of the NBSCI sector (≈ US$ 900 million) are held by the regulated entities while the remaining two thirds are held by the rest. Funding of the NBSCIs includes deposits, bank lending, loans from abroad (including donors and International Financial Institutions-IFIs), and loans/guarantees from the Banco de Desarrollo de la Republica de El Salvador (BANDESAL)153. These institutions target underserved segments of the population, especially the low-income population and micro-enterprises, with a wide range of products, including saving accounts, term deposits, personal credit, home credit, credit for MSMEs, credit cards, insurance and remittances.154 Deposits are protected by the Deposit Guarantee Institute (IGD)155; however, this protection does not extend to non-regulated institutions. The IGD guarantees up to US$10,289 per depositor per institution, of the balances at: (i) savings deposits, (ii) deposits in current accounts, and (iii) time deposits.156 While there is no deposit insurance mechanism for unregulated institutions, some cooperatives have a self-regulated deposit protection scheme.157 The majority of the population (52 percent) is unaware of the protection of deposits by the IGD. 151 Of the cooperative banks, two are incorporated as cooperative associations and four as cooperative societies. 152 Source: INSAFOCOOP. 153 Not all NBSCIs are qualified to intermediate funds according to BANDESAL's policy. 154 Source: FSAP Development Module 2016. 155 In the specific case of BFA, the deposits are not protected by the IGD. 156 e-money is not insured by IGD, but it is 100% backed by BCR. 157 The Draft Cooperatives Law establishes a protection scheme for deposits not incorporated by the IGD. 76 Access to Finance Table 6: Available Financial Products and Services in El Salvador Commercial Banks Non-regulated Product / Service BANDESAL Regulated NBSCIs SACs & NGOs Factoring Firms e-money Providers (Private & Public) NBSCIs Payments X X X X Debit Cards X X X Prepaid Cards e-money X X X Deposits/Savings Simplified Account X X Savings Account X X X Time Savings X X X Credit Microcredit X X X X X Lending to MYPEs X X X X X Lending to Mid-sized X X X X X Firms Mortgage Lending X X Lines of Credit X X X Credit Cards X X Other products and services Leasing X X Factoring X Agents and financial X X X correspondents G2P Government X X X Subsidies Insurance Life Insurance X X Health Insurance X X Other Insurance X X Source: National Financial Inclusion Policy. The Salvadoran authorities have introduced some financial sector measures to mitigate the impacts of the COVID-19 economic crisis. This includes approval by the Legislative Assembly of a fund for the economic recovery of Salvadoran businesses (Fideicomiso para la Recuperación Económica de las Empresas Salvadoreñas, FIREMPRESA).158 The resources of the Trust were channeled directly by BANDESAL and the financial institutions that signed agreements with the Bank to intermediate them. Moreover, the government has announced a reduction of the banks’ reserve requirements by 25 percent for newly issued loans, amendments on provisioning for NPLs through freezing credit ratings, and temporarily relaxed lending conditions through a grace period for loan repayments. 4.2. Access to productive finance in El Salvador El Salvador has made important strides to promote financial inclusion in the last decade (Box 9). However, significant challenges remain with respect to access, quality and use of financial services, as well as the system’s enabling infrastructure to bring their benefits to smaller firms and the base of the pyramid. According to the 2017 World Bank Global Findex Database, less than 30 percent of the population in El Salvador has an account in a formal institution, a percentage that is even lower for the poorest 40 percent, for the rural population and for women. Similarly, according to the 2016 World Bank Enterprise Survey, 25 percent of small firms identified lack of access to financing as an obstacle to their development, while more than 60 percent of them use internal resources to fulfill their financing needs. 158Decreto No. 685, Ley de Creación del Fideicomiso para la Recuperación Económica de las Empresas Salvadoreñas, published July 17, 2020. 77 Access to Finance Women, lower income populations, and adults living in rural areas have the lowest levels of access. According to the latest edition of the 2017 Global Findex Database, women in El Salvador remain 13 percentage points less likely than men to have a bank account, 27 percent less than the regional average (Figure 38). This gender gap stands well above the 7-percentage point gap observed in the region. Adults belonging to the poorest 40 percent report 11 percentage points lower levels of account ownership than the national average. The largest gap is observed between account holders active in the labor force (37 percent) and those out of the labor force (18 percent). Insufficient funds, high costs, and lack of trust in financial institutions were noted as the main reasons to not have an account in a financial institution. To shed light on the reasons why people remain unbanked, the 2017 Global Findex survey asked adults without a financial institution account the reasons for not having one (Figure 38). Distance to a point of access and lack of necessary documentation were indicated as less significant barriers. During consultations159 with various public and private sector stakeholders, lack of documents for identification was also mentioned as a barrier. Figure 38: Selected 2017 Global Findex Indicators of Financial Access Account by individual characteristics (% age 15+) Barriers to Account Ownership (% w/o account) Source: 2017 Global Findex Database Note: LMI = lower-middle-income countries average. LCR = Latin America and Caribbean average. Box 9: Policies and actions conducive to financial inclusion in the last decade • 2012: BCR joined as a member of the Alliance for Financial Inclusion (AFI) and set goals within the framework of the Maya Declaration to promote financial inclusion such as: facilitating the environment for the provision of mobile financial services, developing a financial education strategy, analyzing and defining actions with respect to products for low-income populations (microcredit, microinsurance, micropensions, etc.) and define indicators to measure financial inclusion. • 2015: Legislative Assembly approved the Law to Facilitate Financial Inclusion (Legislative Decree No. 72). • 2016 (between June and November): Approved Regulations to implement the Law on Electronic Money and Saving Accounts with simplified requirements. Rules were also enacted to incorporate the correspondents' administrators into the rules for financial correspondents that were in effect since 2013. 159A National Financial Inclusion Policy World Bank drafting team held consultations with local stakeholders to gauge the level of financial exclusion. 78 Access to Finance • 2016: National Survey on the Demand for Access to Financial Services and National Survey of Financial Capabilities (Financial Education) were conducted. • 2016: Ratification of participation in the inter-institutional agreement on financial education (whose origins dates from 2009) by 9 institutions: the BCR, SSF, IGD, the Consumer Ombudsman, CONAMYPE, MINED, BFA, Banco Hipotecario and BANDESAL. This agreement aims to unify efforts to strengthen the financial capacities of the population, incorporate new entities, and increase public-private coordination under the Financial Education Program, existing since 2008. • 2017: BCR suscribed the Denarau Declaration, committing to work to reduce gender disparities in financial inclusion. • 2017: Micro and Small Enterprise National Survey 2017 conducted by DIGESTYC-CONAMYPE. • 2017 (December 20): an addendum to the framework agreement for cooperation and inter-institutional support in financial education is incorporated, in which the BFA and the BH are added as participants. • 2017 and 2018: Submission of proposals to the Legislative Assembly for the regulation of cooperatives, a matter pending resolution. • 2018: Launch of the digital agenda with five axes of work: digital economy, information security governance, digital government, digital connectivity, and capacity building. MINEC, SIGET, MINED, the Consumer Ombudsman and Ministry of Health participate in this program. Almost all axes can have positive impacts on financial inclusion. • 2018: New inter-institutional financial education agreement signed, incorporating BFA, BH, SSF and CONAMYPE. • 2018: Promulgation of Executive Decree 35, which determines the creation, composition and responsibilities of the National Council for Financial Inclusion. • 2019 (February): BCR published a proposal to work towards strengthening the SMEs, through the report “Generating Capacities for SME and entrepreneurships under a Social and Financial Inclusion Approach.� • 2019: Promulgation of the Executive Decree No. 28, which determines the creation, composition and responsibilities of the National Council for Inclusion and Financial Education, derogating Executive Decree No. 35 of 2018. Source: Own elaboration based on public information. While together consumer and housing lending encompass more than half of total lending, productive lending remains limited and biased towards medium and larger businesses belonging primarily to the tertiary sector.160 Although overall access to transaction accounts is high and demand for credit has been increasing, access to financing for smaller firms remains limited (Figure 39). Of the total lending to businesses, only 16 percent goes to small firms and four percent to micro enterprises (large and medium lending combined comprises 72 percent).161 Due to these limitations, micro and small enterprises in El Salvador indicate using their own resources or drawing from family savings as the main vehicles to finance their working capital needs (Figure 39). Despite higher interest rates, other firms resort to consumer credit to fund their businesses, the provision of which is supplied by a wide range of institutions. There are also a few firms that report using remittances to finance their operations. Although remittances have recently experienced continuous growth, they are expected to drastically shrink due to the COVID-19-related global economic 160 Source: Micro and Small Enterprise National Survey 2017, DIGESTYC-CONAMYPE. 161 Source: SSF 79 Access to Finance contraction and increasing unemployment, further damaging vital financial flows to firms and households. These conditions impose significant challenges to maintain the necessary financial streams to keep the economy afloat. Figure 39: Indicators of Financial Access for Firms Firms w/formal access (by size) Collateral requirements (% of loan amount) Source: WB Enterprise Survey El Salvador 2016. Sources of financing (%) Reasons for credit denial (%) Source: Micro and Small Enterprise National Survey 2017, DIGESTYC-CONAMYPE. The overall normative framework does not favor the provision of credit to smaller firms. There is no regulation or risk management framework to review and monitor the microcredit portfolio, nor a secured transactions framework to simplify movable asset-based lending. The registration, management and enforcement framework for movable collateral is cumbersome, discouraging its use by NBSCIs.162 The fragmentation and lack of definition for microlending does not contribute to the adequate monitoring and evolution of its risks. The lack of prudential oversight for NBSCIs hampers the supervision of over- indebtedness and restricts the generation and analysis of consolidated data on credit supply, which also deters greater access to financing for smaller firms. Overreliance on real estate as collateral, discrepancies in the usage of movable property as collateral, high collateral requirements, and overall weaknesses in 162In El Salvador, the collateral registry is the Centro Nacional de Registros (CNR). While it is used by the banking sector, NBFIs do not make extensive use of it because they consider that its processes impose excessive burdens and costs. For more information see: Superintendencia de Competencia, October 2019. Informe: Competencia en la prestación de servicios financieros a las Micro y Pequeñas empresas (MYPE) en El Salvador. Available at https://www.sc.gob.sv/index.php/sala_multimedia/competenciaserviciosfinancierosmypes/. 80 Access to Finance leasing and factoring are additional contributing factors to discourage borrowing and/or lending. The cumbersome registration and formalization process also constitutes a barrier to the access of credit. Multiple institutions participate in the provision of financial products and services for smaller firms in El Salvador. These institutions range from supervised, unsupervised and informal; however, the portfolio is still relatively small. According to the Superintendencia de Competencia (SC), financing to micro and small firms represented only 13 percent of the total lending portfolio in 2017. Products provided by NBSCIs to smaller firms contain lower document requirements compared to those of commercial banks and include popular credit163, MSME credit164, productive credit, and lines of credit for small businesses165. Despite the multitude of service providers, smaller firms would benefit from a wider range of financial products and services, including factoring, leasing and microinsurance. Factoring is a form of asset-based supplier short-term financing mechanism whereby firms sell their creditworthy accounts receivable at a discount and receive immediate cash. Since the financing is linked to the value of an underlying asset, the creditworthiness of the firm is irrelevant making it particularly attractive to higher risk MYPEs.166 Leasing products enable businesses to use their assets, either under ownership of the lessor, or otherwise, as security to generate capital. Microinsurance is a small-scale risk management instrument to reduce vulnerability. These products are alternatives to the traditional ones because they serve clients that typically fall outside the more-established providers’ business lines and allow financial service providers to further develop their commercial products. All of these products are underdeveloped and lack a clear regulatory framework in El Salvador. Lack of sources of finance are especially harmful for smaller firms, curtailing their growth and further disincentivizing their formalization. At the same time, high levels of informality of smaller firms and individual professionals exacerbates financial exclusion. However, smaller firms could improve their “financial appeal� by formalizing, simplifying internal processes, and adopting affordable technologies (such as accounting systems). 4.3. National Financial Inclusion Policy Since the beginning of 2018, a group of institutions spearheaded by BCR, and with the support of the World Bank, worked towards the development of a National Financial Inclusion Policy (NFIP). This policy provides a roadmap to implement coordinated actions for greater financial inclusion. During the process of consultations and drafting, high level financial inclusion goals and objectives were defined, obstacles and opportunities relevant to the achievement of these objectives were identified, and a prioritized set of actions to pursue in a coordinated manner were outlined. By design, this policy, through its staggered mechanisms of coordination and implementation, its action plan, and its monitoring and evaluation system should enable stakeholders to join forces toward the development of a diverse array of tailored, sustainable and responsible financial products and services. 163 https://www.fedecredito.com.sv/producto/credito-popular 164 https://www.fedecredito.com.sv/producto/credito-para-micro-pequena-y-mediana-empresa 165 http://www.fedecaces.com/site/servicios/prestamos/ 166 See Bakker, Klapper, and Udell (2004) 81 Access to Finance In response to the identified opportunities and challenges to deepen financial inclusion in El Salvador, four priority policy areas and four cross-cutting working areas were defined. The four policy areas (Figure 40) are fundamental pieces to develop and deepen the financial sector in El Salvador. They were determined based on the needs and priorities reflected by the different stakeholders, and in consideration of the institutional framework and enabling environment for a deep and sustainable financial ecosystem in El Salvador. One of the areas focuses on the issue of consumer empowerment, while the others relate to a set of financial products and services and include financing of micro and small firms (MYPEs in Spanish). Figure 40: NFIP Policy Areas Source: National Financial Inclusion Policy. Authorities and private stakeholders recognize the importance of achieving increased access to financing by MYPEs. There are currently some programs in place to address the financial needs of the MYPEs such as “Banca EmprendES,� “Banca Mujer,� and “Banca Agropecuaria,� executed by BANDESAL167, and FONDEPRO168, a fund to provide non-reimbursable financing (grants) for MSMEs to strengthen competitiveness and generate economic impact, sponsored by the Ministry of Economy. The NFIP helps articulate these initiatives and coordinate them with other providers working on topics related to the lack of access to adequate financial products (such as informality or low levels of productivity). 167 Banca EmprendES is a program from BANDESAL destined to finance entrepreneurs interested in starting or developing productive or commercial endeavors, which include investment in capital formation, current expenses or working capital and provision of services, among others. Banca Mujer is a program from BANDESAL intended to promote economic autonomy and financial inclusion of women entrepreneurs, facilitating credit lines, guarantee lines, and capacity building through training and technical assistance. Banca Agropecuaria is a program from BANDESAL with the objective of promoting the development of micro, small and medium agricultural producers, through access to financing, guarantee programs and training, for profitable agricultural and livestock activities that generate added value. For more information see: http://www.bandesal.gob.sv/programas/ 168 http://www.fondepro.gob.sv/institucion/ 82 Access to Finance In order to define, coordinate, and implement the NFIP, a governance structure was created incorporating high-level public actors to facilitate decision-making and continued collaboration. The governance arrangements include a high-level Council169 and an Implementation Committee170. They also envision a Secretariat housed at the BCR and working groups with clear objectives and mandates comprised of public and private stakeholders. The competences and powers of each of these bodies as well as the participation of the private sector are detailed in the Executive Decree No. 28 of 2019.171 The NFIP Action Plan pre-identifies general actions and includes measures and indicators to achieve its objectives. Operationalizing the action plan requires shifting from high-level actions to operational work plans based on a theory-of-change approach. Specific actions and activities should be prioritized and sequenced in consultation with GATIF member entities and other public and private sector stakeholders through the working groups. The Action Plan was designed to last for 4-5 years during which adjustments to the actions and activities, terms, and/or responsible entities could be reformulated depending on the circumstances. Finally, in order to measure progress, identify obstacles and introduce corrective actions, a Monitoring and Evaluation (M&E) mechanism was envisaged. This mechanism includes: (i) data infrastructure, (ii) results framework, (iii) action plan tracking system, and (iv) efficiency, effectiveness and impact evaluations of the actions. Box 10: Selected high-level actions in the NFIP Action Plan Strengthening financial and credit infrastructure • Improve access and interconnectivity of retail payment systems (Banks and NBFIs) Improving the legal, regulatory and supervisory framework for credit • Expansion of the regulatory perimeter for systemically important NBSCIs • Strengthen supervisory capacity • Increase inter-institutional as well as public-private cooperation Improving the financial consumer protection framework • Integrate regulated and non-regulated providers to comply with the framework • Promote the dissemination of resolution/redress mechanisms Promoting and developing products and alternative sources of financing • Development of financial products tailored to the needs of MYPEs • Establish a framework for leasing based on international standards and good practices • Improve the framework for factoring based on international standards and good practices Source: NFIP Action Plan. 169 The Consejo Nacional de Inclusión y Educación Financiera (CNIEF), is the highest level governance structure of the NFIP and consists of the heads or high-level delegates from: (i) BCR, (ii) SSF, (iii) MINED, (iv) BANDESAL, (v) the Consumer Ombudsman, (vi) CONAMYPE, (vii) IGD, (viii) BFA, and (ix) MINEC. 170 The Grupo de Apoyo en Temas de Inclusión Financiera (GATIF), is the implementation committee of the NFIP and consists of appointed technical-level staff members and alternates from: (i) BCR, (ii) SSF, (iii) BANDESAL, (iv) the Consumer Ombudsman, (v) CONAMYPE, and (vi) MINEC. 171 https://www.transparencia.gob.sv/institutions/capres/documents/indice-de-decretos-ejecutivos 83 Access to Finance 4.4. The role of the state in the provision of finance: the visible hand172 The design of the NFIP revealed the need for better coordination and collaboration between the public and private sectors. This is reflected in different actions that call for better inter-institutional coordination, such as memoranda of understanding (MoUs) between public entities173, private entities, or both174. Understanding that the financial system is more efficient and effective through complementarity, avoiding direct competition between the public and the private sectors can be a guiding principle for improving financial access and maintaining financial stability. The public sector plays a key role in the financial ecosystem. It should create an enabling, integrated and leveled institutional framework guided by the principle of proportionality. World Bank diagnostics and technical assistance interventions have found uneven and fragmented institutional frameworks in El Salvador.175 Conditions such as multiple oversight bodies increase costs, discourage fair competition, and generate barriers to entry and exit. The public sector should set up a financial infrastructure that allows the providers of financial products and services to, inter alia, reduce their costs, increase their risk tolerance by expanding the risk frontier, and reduce information asymmetries. The state is the catalyst for public-private collaboration, and, in some cases, can be a provider of financial products and services. The appropriate role of the state in the financial sector has evolved in recent decades.176 The current prevailing view of “pro-market activism� is at an intermediate stage between public interventionism and free market or laissez-fare views.177 The interventionist view emerged during the 1950s, when the consensus was that the state played a key role in the development process through an array of instruments such as state-owned financial institutions (SOFIs) and development banks (DBs), and argued that market failures by themselves could not be overcome by the market itself. However, direct state intervention was subsequently found to have weaknesses by introducing market distortions. The free market178 school of thought emerged in the 1970s and 1980s with the idea that public resources used in the financial sector would not only be sub-optimally used but even obstruct economic development. At this stage, bank privatizations and deregulation began to occur and while some successes were documented, they came at a price. Finally, the most current view, or intermediate paradigm, sometimes called pro-market activism179, recognizes a role for the public sector to improve the enabling environment 172 The term “the Visible Hand� was used by de la Torre, Gozzi, and Schmukler (2017), Innovative Experiences in Access to Finance: Market-Friendly Roles for the Visible Hand?, World Bank Group. https://openknowledge.worldbank.org/handle/10986/27529 173 Strengthening the coordination between BCR and SSF to improve regulatory and supervisory capacity, or between SSF and the Consumer Ombudsman to minimize conflicting measures and ensure the complementarity of their roles have been recommended on the FSAPs. 174 MoUs between credit bureaus and collateral registries could support the evaluation of credit risks and improve the enforcement of collateral by establishing that lien holders are governed by the publicity and priority rules of a harmonized norm. 175 A fragmented regulatory framework for providers of similar services creates an unlevel playing field and increases the risk of regulatory arbitrage. 176 The following section is based on Abraham, and Schmukler (2017), A New Role for Development Banks?, Research & Policy Briefs, World Bank Group. 177 de la Torre, Gozzi, and Schmukler (2017). 178 Also known as laissez-faire or invisible hand. 179 de la Torre, Gozzi, and Schmukler (2017). 84 Access to Finance and highlights the potential benefits of development banking as a provider of financial services in the presence of an identified market failure. One of the benefits of pro-market activism is the countercyclical role that SOFIs and DBs can play during periods of crisis. The economic literature shows that SOFIs have the ability to more nimbly adopt significant measures intended to alleviate the effects of economic downturns or financial crises.180 During these periods, SOFIs—particularly those furnished with good corporate governance arrangements—are better equipped to increase their supply of loans, expand their scope to reach new sectors and affected groups of borrowers, inject liquidity, purchase assets, and/or acquire ownership stakes in distressed private financial institutions. The state and private financial institutions are critical to mitigate the impacts of the COVID-19 crisis as providers of liquidity to viable firms. Many countries are implementing instruments such as lines of credit and partial credit guarantee schemes.181 However, the range of available options is limited by the sophistication of their institutional frameworks, the capacity of the financial sector to execute them, and the flexibility of the government’s fiscal space. Box 11: Good international practices on the provision of finance by the State The variety, complexity and specialization of State-Owned Financial Institutions (SOFIs) make it difficult to highlight a single case of best international practice. Section 4.4 of this report evaluates the risks associated with public sector interventions in the provision of financial services. It also highlights the advantages of having a public financial sector framework to unlock financial constraints and promote economic development in times of crisis. A review of the literature on Development Banks shows institutions with strengths worthy of best practice, but with weaknesses in other areas. A solid framework and network of SOFIs should include institutions that provide additionality through the resolution of market failures and the establishment of sunset clauses to avoid the introduction of distortions by crowding out private participants. They need an adequate corporate governance arrangement that insulates them from political capture or decision making. Arrangements should incorporate adequate risk management practices, encourage innovative products, and create the conditions for competitive participation. Examples of institutions/frameworks based on individual strengths include: Structured financial instruments • Fannie Mae and Freddie Mac (United States) • FIRA (Mexico) Public provision of market infrastructure • Back-office services: BANSEFI (Mexico) • Correspondent banking (Brazil) • Reverse Factoring: NAFIN (Mexico) Microfinance • Banco do Nordeste (Brazil) 1802017 Survey of National Development Banks, World Bank. 181There is a range of other possible instruments that could be drawn upon, such as debt securitization or structured finance, private equity, hybrid instruments, or crowdfunding among others, but they require a certain degree of development, or rely on certain technology or framework in place. 85 Access to Finance • Bank Rakyat (Indonesia) Credit Guarantees • BBMKB (Netherlands) • FOGAPE (Chile) • KODIT (South Korea) 4.5. Development banks, public banks and public financial instruments in El Salvador The state-owned banking system (SOBS) has been assigned the role of promoter of access to credit for MYPEs, according to the MYPE Law.182 The SOBS should execute this role in consultation and coordination with the Ministry of Economy (MINEC). It should also create and strengthen financial instruments, guarantee systems, trust funds, risk capital and leasing, among others. The article also establishes that this process could be done directly or through all financial intermediaries serving MYPEs. The Public Banking System is comprised of two commercial banks: Banco de Fomento Agropecuario (BFA)183, and Banco Hipotecario (BH)184, one development bank: BANDESAL185, and five trust funds186: Fondo de Desarrollo Económico (FDE), Fondo Salvadoreño de Garantías (FSG), Fondo Social para la Vivienda (FSV), Fondo Nacional de Vivienda Popular (FONAVIPO), and Corporación Salvadoreña de Inversiones (CORSAIN). The three banks and the funds are all supervised by the SSF. While BANDESAL is primarily a second-tier institution its charter, mandate and objectives have been reformed by the legislative decree number 653 (June 2020). The decree introduced changes to the corporate governance of the institution and lifted some restrictions to facilitate first-tier operations. BANDESAL manages FDE and FSG187 and is not authorized to take deposits. It is mainly funded by lines of credit from international and regional financial institutions and debt issuance.188 Banco de Fomento Agropecuario provides small loans to an underserved market segment comprised mainly of micro-farmers. Its main source of funding is small deposits, some of them from public institutions. BFA is one of the public sector financial institutions with better outreach and regional presence in the country. However, there are high credit risks and volatility associated with its business model, and it has high administrative costs. Banco Hipotecario is a state-owned bank with private sector participation focused on lending to MYPEs in a diversity of sectors and is expanding into the micro enterprise. Neither BFA nor BH would be able to expand without an increase in their regulatory capital.189 There are several government programs with a shared goal of increasing access to credit for MYPEs. These programs would benefit from better articulation and coordination both amongst 182 See Article 45, https://www.asamblea.gob.sv/decretos/details/1767 183 https://www.bfa.gob.sv/BFA/. 184 https://www.bancohipotecario.com.sv/ 185 http://www.bandesal.gob.sv/ 186 BANDESAL is governed by the Law of the Development Bank of the Republic of El Salvador. See Article 45, https://www.asamblea.gob.sv/decretos/details/1767. 187 FSG is a partial credit guarantee fund managed by BANDESAL. 188 FSAP Development Module 2016 (Technical Note on Public Banks). 189 Idem. 86 Access to Finance themselves and with the private sector to avoid crowding-out and overlaps. BANDESAL, BH, MINEC, and CONAMYPE are the main operators of these programs. Additionally, CONAMYPE manages programs on formalization, capacity building, as well as technological development and assistance that are relevant to improve the capacities of MYPEs to access credit (see Chapter 5 on Innovation and Entrepreneurship). Lines of credit and partial credit guarantees could be expanded to help firms confront the COVID-19 crisis. The instruments could be tailored to the needs of micro and small firms affected by the crisis and with potential to participate in certain global value chains. • Lines of Credit. A line (or lines) of credit could be intermediated by BANDESAL to participating financial institutions (PFIs) for on-lending to MYPEs. PFIs could be commercial banks or other non-bank financial institutions, such as cooperatives that meet the eligibility requirements. The line(s) of credit could be established directly or through a trust structure administered by BANDESAL and overseen by the key government entities tasked with supporting the sustainable recovery of MYPEs, e.g. CONAMYPE and the Ministry of Economy. The governing board would determine the target sectors, eligibility criteria (both for PFIs and borrowing MYPEs), and loan conditions. BANDESAL would be responsible for the fiduciary and risk management functions. Lines of credit could be the preferred option when the PFIs have limited liquidity to expand lending to target MYPE segments. • Partial Credit Guarantees. BANDESAL’s Fondo Salvadoreño de Garantías could potentially be expanded to cover a portion of the loans offered to MyPEs by the PFIs. PCGs would be the preferred option when PFIs have adequate liquidity but a reduced risk tolerance due to the crisis. PCG schemes have the benefit of leveraging public resources to benefit more borrowers. (For example, with a leverage of 4, a partial credit guarantee scheme can guarantee commitments that are 4 times the amount of its capital.) Firms support and recovery programs should be coordinated across government institutions. BANDESAL, MINEC, and CONAMYPE have various firm support programs that aim to increase access to finance. Additionally, CONAMYPE manages programs on formalization, capacity building, and technology development that are relevant to improve the capacities of MYPEs to access credit (see Chapter 5 on Innovation and Entrepreneurship). These programs should be coordinated across government institutions and with the private sector to maximize complementarities. 4.6. Suggested Access to Productive Finance Action Plan The financial sector has a central role in the development agenda of El Salvador and could play a pivotal role to mitigate the impact of the COVID-19 crisis. An expansion of second-tier operations of BANDESAL could strengthen this role in the short term. A simultaneous focus on maintaining financial stability is needed to avoid a financial crisis that could only amplify the negative effects of the economic crisis. Better inter-institutional and sectoral coordination would be key to maintain a level playing field, avoid unfair competition and market distortions, and suppress crowding-out effects. Improvements on risk management processes, governance arrangements, and enhanced supervision are also needed. 87 Access to Finance Fiscal Timing: Required cost (ST): Responsible ST (<1 Reform Action legal none, Entity year), MT change small, (>1 year), large Strengthen BCR and SSF coordination through an MoU to improve regulatory BCR & SSF ST N None and supervisory capacity Study and elaborate a bill of BCR & SSF MT Y None Cooperatives and SACs A. Regulation Expand the regulatory perimeter for and systemically important NBSCIs BCR & SSF MT Y None supervision proportional to their risks Promote digitalization of transactions to distribute government assistance programs (subsidies - G2P) and BCR ST N None facilitate payments (and consequently increase financial access). Strengthen the liquidity framework B. Liquidity (including supervision and consider the BCR & SSF MT Y Small framework introduction of a Liquidity Fund) • Refocus BANDESAL’s role as a Development Bank to focus on second-tier operations and rethink its first-tier role • Expand BANDESAL’s second-tier operations both for loans and guarantees to address COVID-19 firm financing needs • Expand BANDESAL’s offer of credit enhancement instruments • Disseminate and socialize the FSG to MH, MINEC, C. State-owned facilitate the provision of credit BANDESAL, Small to ST/MT Y banking system (possibly inject capital) BH, BFA, Large • Consider designing programs CONAMYPE administered by state-owned financial institutions to expand liquidity through the financial sector (possibly in coordination with CONAMYPE). • Expand the regulatory capital of BH and BFA • Improve the articulation of strategies for public sector intervention D. Inclusion Launch and implement the NFIP CNIEF ST N None 88 5. Innovation and Entrepreneurship190 Innovation is a key driver of productivity and economic growth. Innovation is one of the internal factors triggering productivity growth at the firm level, which in turns influences overall productivity (Syverson, 2011). Because of their non-rival nature, ideas are the engine behind productivity growth, which in turn determines long-term economic growth and quality of life. An idea can be used, replicated and expanded by other entrepreneurs. Through the accumulation of ideas, production rises even with constant factors of production (Romer, 1990). This process leads to business renewal in which obsolete good, services or process are replaced by recent inventions (Schumpeter, 1942). Empirical evidence shows that innovations explain economic differences over a century (Akcigit et al., 2017) and that in the long run productivity improvements explain up to 50 percent of GDP growth (Easterly and Levine, 2001). Innovation is also strongly associated with social mobility (Aghion et al., 2018). In developing countries, innovation is not only based on knowledge creation arising from research and development (R&D), but also technology adoption and incremental innovation. In this sense, innovation is intricately linked to entrepreneurial activity.191 Developing countries tend to underinvest in innovation as entrepreneurs do not take advantage of opportunities to adopt global knowledge. Global technological advancements and the technology gap between developing countries and those in the frontier are associated with high expected returns that translate into opportunities for entrepreneurs to catch-up. Yet, Cusolito and Maloney (2018) find that entrepreneurship (particularly highly-educated entrepreneurs) increases with the level of development. In other words, individuals in developing countries are not seizing these opportunities, which constitutes a paradox. Unfriendly business environments and low entrepreneurial capabilities in developing countries may explain the paradox of low levels of entrepreneurship amid great catch-up opportunities. Poor business conditions and missing complementary factors and markets for innovation decrease the returns of technological adoption (Cirera and Maloney, 2017). The lack of good quality information, barriers to entry or exit, weak institutions, and restricted access to finance, among others, limit profitability or the ability of individuals to take advantage of the opportunities. Furthermore, even in business-friendly environments, low educational levels, poor managerial and technological capabilities, risk aversion, and negative cultural biases towards entrepreneurship can prevent it from flourishing (Cusolito and Maloney, 2018). Policies to promote entrepreneurship and innovation should tackle both operating environments and entrepreneurial capabilities. With the firm at the center, public policies should 190 The analysis in this chapter is based on work done for the IFC Central America Digital Entrepreneurship Advisory Services Project (#603894), in collaboration with the Finance, Competitiveness and Innovation Global Practice, and it will be part of a forthcoming paper entitled “Local entrepreneurship ecosystems in Central America�. The paper is being prepared by Marcio Cruz and Jesica Torres Coronado, with key inputs from Gabriela Montenegro, and overall guidance from the project team leaders, Mayra Alfaro de Morán and Pedro Andres Amo. This chapter was prepared by Mónica Parra Torrado and Thomas Haven in collaboration with the IFC team. 191 This chapter refers to entrepreneurship as the activity of developing a commercial idea, forming a business, and taking risks in order to generate economic benefits. The chapter also discusses young businesses that are already established. 89 generate the incentives to invest, strengthen firm capabilities, and develop entrepreneurial characteristics. These should aim at removing barriers and opening markets. Also, governments should provide public goods, strengthen education and training systems, and promote entrepreneurial- and innovation-enabling actors. All of these make up the entrepreneurial ecosystem as described in the next section. This chapter is comprised of the following five sections. The first section explains the entrepreneurship conceptual framework, which serves as basis for the rest of the chapter. The second section describes El Salvador’s innovation and entrepreneurship performance compared to peer countries. The third section presents the identified local entrepreneurship ecosystems in El Salvador. The fourth section summarizes the entrepreneurship and innovation policies carried out by the government. The fifth section presents a concrete action plan to address the most pressing issues and seize opportunities identified in the previous sections. 5.1. Entrepreneurship ecosystem conceptual framework An entrepreneurial ecosystem is a set of complementary factors, such as knowledge and resources, available through institutions and individuals within a region to support the development of new and economically impactful businesses.192 Building on Cirera and Maloney (2017) and Cusolito and Maloney (2018), the World Bank developed a methodology to assess entrepreneurial ecosystems (World Bank, 2020a). The entrepreneurial ecosystem is defined by two main parts: the initial conditions with key supply and demand factors and barriers, and the entrepreneurship outputs and outcomes. Entrepreneurs/firms, governments, and intermediary organizations interact within the ecosystem. Entrepreneurs need physical, human, and knowledge capital to transform ideas into products and services. The initial conditions include supply factors such as physical capital (infrastructure, telecom bandwidth, imported machinery, FDI193, etc.), human capital (education and training systems), and knowledge capital (laboratories, efficient patent rights, universities, researchers, technology extensionists). These factors are presented on the left side of Figure 41. Incentives for market access, firm capabilities and entrepreneur characteristics are essential to transform resources. The initial conditions of the entrepreneurial ecosystem also include demand factors such as the market incentives to export and participate in global value chains. Firm capabilities to manage enterprises, such as valuing, pricing, book-keeping, risk management and other actuarial and innovation capabilities are needed to recognize and take advantage of opportunities for technological catch-up. Likewise, personality traits (drive, grit, risk attitude, openness, innovativeness) and experience can influence the success of entrepreneurs. Demand factors are portrayed on the right side of Figure 41. Access to finance, pro-business regulations and social capital enable entrepreneurs to thrive. The third element of the initial conditions is accumulation and allocation barriers. As previously discussed, the operating environment can either restrict or encourage entrepreneurial activities. Developed and 192 Excerpt from World Bank (2020a), page 12. 193FDI can improve the quality of domestic firms by imitation, knowledge sharing, employment-related transfers, and incentives to competition. 90 inclusive financial markets that provide accessible funding throughout all stages of firm development are indispensable for starting and growing businesses. Regulatory frameworks that allow for fluent entry and exit of firms boost productivity and generate dynamic ecosystems. Moreover, cultural attitudes towards entrepreneurship can promote the creation and implementation of new business idea. A positive attitude in the society towards entrepreneurship as a career choice and the existence of networks encourages entrepreneurial activities. These elements of the ecosystem are depicted at the center of Figure 41. The combination of supply and demand factors within a healthy operating environment result in job creation, increased exports, innovation, and productivity growth. Under this conceptual framework, entrepreneurial outputs and outcomes are assessed in terms of firm dynamics (entry, exit, survivorship) and entrepreneurship impact (jobs, revenues, exports, innovation, productivity growth). These are portrayed at the top of Figure 41 in yellow. Policy makers can influence the entrepreneurial ecosystem to maximize job creation and economic growth by addressing market failures. Market failures may arise in any of the initial conditions of the entrepreneurial ecosystem. These failures can be associated with supply or demand factors or associated with the barriers to accumulation and allocation.194 Governments intervene in the ecosystem directly through policy instruments and regulations or indirectly through intermediary organizations that support entrepreneurship (bottom of Figure 41 in red). By doing so, they must consider the natural interactions between factors and barriers portrayed in Figure 41 with green arrows. Figure 41. Entrepreneurial ecosystem framework Source: World Bank (2020a). Note: Green arrows added by author. 194Some of these failures can be government failures or inefficiencies created by interventions of the government itself (e.g., distortive regulations). 91 5.2. Entrepreneurship and innovation in El Salvador Entrepreneurship in El Salvador lacks dynamism, exhibiting low firm creation and growth. The registration of new businesses in El Salvador is lower than what would be expected considering its level of development (Figure 42). In fact, the share of young formal businesses, those with at most three years in operation, is only 0.7 percent, compared with 1.3 percent in Central America and 3.2 percent in the LAC region (Figure 43). Furthermore, existing formal firms exhibit limited growth. In 2016, employment increased by only 2 percent while it increased 3.7 percent on average in LAC countries (Figure 44). This feature is reflected in the relatively small size of formal firms that have been operating for twenty years. While the average size of 20 year-old firms in the region is 51 workers, in El Salvador the average size is 33 workers (Figure 45). Also, the share of entrepreneurs that hire employees is only 14 percent, compared to twice that number in Costa Rica (Figure 46). Figure 42. Registration of new businesses and Figure 43. Share of young formal firms GPD per capita, 2018 (0-3 years in operation), 2016 Figure 44. Employment growth in formal firms Figure 45. Average size of formal firms with more (%), 2016 than 20 years in operation (# of workers), 2016 Figure 46. Share of entrepreneurs with employees, 2016 Source: WDI, WB Enterprise Surveys (WBES) various years (Colombia and Guatemala: 2017; Costa Rica and Mexico: 2010; Honduras and El Salvador: 2016). 92 El Salvador’s innovation performance lags behind other countries with similar levels of development. The country ranked 92nd among 131 countries in the 2020 Global Innovation Index (GII) study, gaining 16 places from the 2019 ranking (Figure 47). However, that the score was unchanged (24.9) meaning that the improvement was not absolute, but relative to the performance of other countries. Among 19 LAC countries and 26 lower-middle income countries, El Salvador ranked 12th and 11th respectively. Compared with countries of a similar level of development, such as Vietnam and the Philippines, El Salvador lags behind (Figure 48). According to the analysis in this chapter, El Salvador has several weaknesses that holds back innovation. The most prominent ones are underdeveloped innovation linkages (clusters, university-industry collaboration, joint venture deals); low knowledge creation, technology adoption, R&D investment and education quality; poor regulatory and business environments; and lagging infrastructure. Figure 47. Global Innovation Index Ranking, 2020 131 97 99 103 105 106 85 90 92 73 76 80 62 68 69 48 50 54 55 56 1 3 14 42 Dominican… Viet Nam Mexico China Panama Indonesia Argentina Paraguay Colombia Ecuador Switzerland Costa Rica Peru Honduras India Guatemala Yemen Philippines Chile Brazil El Salvador United States Uruguay Bolivia Source: GII, 2020. Figure 48. Global Innovation Index and GDP per capita, 2020* 80 Bubbles sized by population CHE USA 70 CHN GBR SWE NLD KOR FINDEU DNK JPN FRA ISR CAN HKG 60 GII score, 2020 CZE AUT BEL AUS ISL NOR ESTESP ITA NZL MLT IND CYP PRT SVN 50 MYS HUN ARE VNM BGR RUS POL LVA LTU PHL UKR THA HRV TUR GRC ROU ZAF BRA MKD MEXMNE SRB CHL MUS 40 MNG MDA ARM TUN PER GEO COL MKD CRI BLR URY SAU KEN MAR JOR IDN JAM ALBBIH AZE ARG KAZ PAN OMN BHR BRN RWA NPL SEN TJK PAK NGA BGD HND GHA LKA LBN BWA ECU PRY DOM TTO 30 MWI MDG UGA BFA CMR KHM CIV MOZ NER TGO MLIGINZWE BEN ETH ZMB GTM NAM DZA 20 BOL SLV 10 750 7500 75000 GDP per capita in PPP$, 2019 (logarithmic scale) Source: GII (2020) and World Development Indicators. The latest data available for GDP per capita is 2019. Historically, the innovation efforts and technology adoption are limited in El Salvador. However, recently there has been a significant drive from the Innovation Secretariat to improve the innovation ecosystem. Less than 15 percent of Salvadorian firms have introduced innovations into their production processes (Figure 49) and less than 6 percent invested in R&D in 2016 (Figure 50). These shares are about half of the Central America average and far lower than the LAC averages. Investment in R&D activities (basic research, applied research, and experimental development) in Latin America is already very low (0.88 percent of GDP, average) compared with developed countries such as Germany or Sweden (about 3 percent of GDP). However, the investment effort in El Salvador is considerably lower with barely 0.18 percent of GDP (Figure 51). This behavior is reflected in low participation in manufacturing exports of 93 products with a high R&D component, such as aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery. Whereas in Costa Rica and Mexico, the share of high-tech manufacturing exports is 18 percent and 21 percent respectively, in El Salvador it only reaches 6 percent (Figure 52). Nevertheless, the Government of El Salvador has recently made progress on several fronts to increase the dynamism of the innovation ecosystem, including the implementation of the Digital Agenda and several actions carried out by the Secretariat of Innovation (e.g., the creation of an innovation observatory, identification of bottlenecks and improvement of the regulatory environment, modernization of the State, among others). Figure 49. Percentage of firms that introduced Figure 50. Percentage of firms investing in R&D innovations Source: WBES various years (Colombia and Guatemala: Source: WBES various years (Colombia and Guatemala: 2017; Costa Rica and Mexico: 2010; Honduras and El 2017; Costa Rica and Mexico: 2010; Honduras and El Salvador: 2016). Salvador: 2016). Figure 51. GDP share of R&D investment Figure 52. Percentage of high-tech manufacturing exports Source: WDI various years (Colombia: 2018; Guatemala, Source: WDI various years (Guatemala and Honduras: 2017; Honduras, El Salvador and Costa Rica: 2017; Mexico: 2016). all others 2018). El Salvador lags in human and physical capital, factors of production that are key in the development of the entrepreneurial ecosystem. In El Salvador, only 6 percent of people age 25 and above have completed tertiary education, compared to 15 percent in Mexico and 21 percent in Costa Rica. Among graduates, 22 percent obtain science or engineering degrees, which compares with percentages in more developed countries (Figure 53). This is an important result that could be leveraged considering the complementarities with technology adoption. Knowledge capital is also low in El Salvador: there are 66 researchers per million people, whereas Costa Rica has about eight times that number (Figure 54). However, the integration of the "entrepreneurial culture" as a transversal axis of technical training in the country stands out as a strong point. Since 2012, the Ministry of Education, Science and Technology (MINEDUCYT) has incorporated Entrepreneurship as a transversal axis in the training of young people in the Technical Vocational High School and in the articulated careers of the higher technological level institutes of the Gradual Educational Model of Technical and Technological Learning (MEGATEC). 94 MINEDUCYT promotes the Entrepreneurial Culture Training Program to contribute to the generation of entrepreneurships that are driven by young people in the technical area. By 2020, the program has trained 2,200 teachers, educated 217,000 students, and delivered, through 2017, seed capital support for equipment and tools to 264 entrepreneurships — which were also formally legalized.195 Regarding physical capital and digital infrastructure, El Salvador has mixed results. The country performs well in some basic indicators such as universal electricity coverage that it is not attained in all LAC countries. However, the country lags behind in infrastructure relevant to digital business and related activities. The percentage of the population using the internet in El Salvador is relatively low compared to countries such as Colombia, Mexico and Costa Rica (Figure 55). There are several reasons that contribute to lower internet users, including cost of internet access, infrastructure deployment, and demand issues (e.g., skills). According to data from the International Telecommunication Union there is still 30 percent of the population in El Salvador without 4G coverage (latest data, 2018). The prices of mobile and fixed broadband packages are remarkably high for the majority of the population. This is reflected in the fact that most subscriptions are prepaid so that the population does not have access to internet on a continuous basis. This situation poses a significant challenge not only to digital firms but more generally to the whole economy facing the COVID-19 crisis and post-pandemic scenario. Adding to these findings, as shown in Chapter 3, FDI inflows in El Salvador have been stagnant over the past decade, which is one of the known channels through which knowledge is transferred to local firms. Figure 53. Percentage of tertiary and sciences Figure 54. Number of researchers per million and engineering graduates people Source: WDI various years (Colombia, Costa Rica and Mexico: 2015; Guatemala and Honduras: 2014; El Salvador: Source: GII 2019. 2013); GII 2019 for STEM graduates share. Figure 55. Percentage of population using . Internet Source: GII 2019. 195 According to information provided by MINEDUCYT during the preparation of this document. 95 Despite relatively good participation in regional and global markets, Salvadorian firms still lack key demand factors to convert accumulation of knowledge and resources into entrepreneurship.196 El Salvador has relatively good access to international markets as compared with countries in the region. About 13 percent of firms export at least 10 percent of sales, a share close to the LAC average of 14 percent and only exceeded by Uruguay, Peru and Guyana. Likewise, the share of manufacturing firms that use imported materials or supplies (68 percent) is closed to the LAC average of 70 percent. Nevertheless, as discussed in Chapter 6, El Salvador participates mostly in global value chains of low value-added manufacturing products and with few countries, limiting the growth potential. Furthermore, firms lack the capabilities needed to transform capital into productive entrepreneurship. For instance, only about 5 percent of firms are internationally certified, compared with a little more than 10 percent of firms in Honduras and 24 percent of firms in Mexico. Also, less than half of firms have official websites, compared to 58 percent of firms in Guatemala and 80 percent of firms in Colombia. On the other hand, there has been a large increase in the use of digital technologies during the COVID-19 pandemic. According to Enterprise Surveys conducted by the World Bank, around half of the formal enterprises in El Salvador initiated or increased the use of digital technologies.197 Figure 56. Percentage of firms exporting directly Figure 57. Percent of manufacturing firms using or indirectly at least 10 percent of sales material inputs and/or supplies of foreign origin Figure 58. Percentage of firms internationally Figure 59. Percentage of firms with official certified websites Source: WBES various years (Colombia and Guatemala: 2017; Costa Rica and Mexico: 2010; Honduras and El Salvador: 2016). Salvadorian entrepreneurs are self-confident and motivated, positive traits that could be further leveraged. One third of adults in El Salvador admit that they would not start a business for fear of failure, a percentage slightly above the LAC average (Figure 60). This indicator reflects the attitude of individuals towards risk that would allow them to embrace challenging opportunities or prevent them from doing so. It reflects the perceived opportunity cost of becoming an entrepreneur instead of following other career options, which tend to be higher in developed countries. Also, this indicator may reflect regulatory distortions or social biases that increase the risk of starting a business. A relatively high 196 See Paragraph 188, which discusses the demand-side factors analyzed in this report. 197 World Bank Enterprise Survey: Follow-up survey for COVID-19, December 2020 - January 2021. 96 proportion (70 percent) of adults in El Salvador consider themselves capable and knowledgeable to start a business, compared with the LAC average of 62 percent (Figure 61). This characteristic could give entrepreneurs the drive and confidence to work hard and succeed in their business. Nonetheless, it should be considered with caution given that managers in developing countries tend to believe they are more capable than they actually are (based on data from the World Management Surveys). This can prevent entrepreneurs from accepting advice for improvement. The motivation to start a business is a key determinant of the potential growth of the business. In El Salvador, there are almost the same number of entrepreneurs “out of opportunity� motivated to improve their situation than entrepreneurs “out of necessity� (Figure 62). This proportion echoes the quality and potential of entrepreneurship. Figure 60. Percentage of adults who fear of Figure 61. Percentage of adults who believe they failure would prevent them from starting a have the required skills and knowledge to start a business business Figure 62. Motivational index (improvement-driven opportunity entrepreneurs versus those motivated by necessity) Source: Global Entrepreneurship Monitor (2016). There is no 2016 data available for Honduras, Mexico and Costa Rica and using the latest data for all countries resulted in distorted results. Access to finance is one of the key constraints to expanding entrepreneurship in El Salvador. Limited funding hinders firms’ growth and leads to a greater share of small firms in the ecosystem. As discussed in Chapter 4, despite government efforts over the last decade, financial inclusion in El Salvador continues to be a challenge. While in most Latin American countries more than 90 percent of formal firms hold bank accounts, in El Salvador the share is 84 percent. Likewise, only 40 percent of formal firms have bank loans compared with 57 percent in Costa Rica and 62 percent in Colombia.198 In addition, access to early stage funds and venture capital is limited, which generates a gap for financing innovation, decreasing the creation of new firms, and limiting their growth. According to the World Economic Forum, El Salvador ranks 148th out of 165 countries in the availability of venture capital. As also mentioned in Chapter 4, access to finance is more restricted for small enterprises and women. The business regulatory environment in El Salvador constrains entrepreneurial activity and encourages the creation of informal businesses. Friendlier regulatory frameworks promote productivity growth by allowing for more efficient allocation of resources among firms, positively affecting 198 Source: WBES various years (Colombia and Guatemala: 2017; Costa Rica and Mexico: 2010; Honduras and El Salvador: 2016). 97 entrepreneurship, business formalization, access to finance, and global market integration. El Salvador’s business regulatory environment challenges are discussed in detail in Chapter 2. The Salvadorian entrepreneurial ecosystem is characterized by strong social capital when compared with its peers, although important gender gaps persist. In El Salvador, being an entrepreneur is a generally respected career choice (Figure 63). This cultural acceptance influences positively individuals to take risks and start businesses. Moreover, access to networks of entrepreneurs increases the chances of success. Salvadorian men enjoy relatively large networks with half of adult males knowing personally entrepreneurs, a proportion slightly higher than the LAC average. However, only 35 percent of women have access to entrepreneurial networks decreasing their odds of success (Figure 64). In fact, an important gender gap is observed in the country: a greater share of women than men (44 vs. 29 percent) decide to become entrepreneurs out of necessity while a smaller share of women than men (56 vs. 70 percent) become entrepreneurs because they see an opportunity (Figure 65). Despite this, almost one third of formal firms in El Salvador are managed by women, double the share in Mexico and Costa Rica (Figure 66). Ecosystems gain dynamism when women are also provided with factors of production and gender biases are removed. El Salvador has a great challenge in this respect, considering that female-led enterprises can create more jobs (2.6 vs 1.1 percent in 2016), but labor productivity growth was negative (-2.3 vs 2.9 percent) and sales growth practically zero (-0.1 vs 3.7 percent).199 Figure 63. Percentage of adults who believe that Figure 64. Percentage of adults who personally entrepreneurship is a good career choice know entrepreneurs Figure 65. Ratio of female to male Figure 66. Percentage of firms with a female top entrepreneurship manager Source: WBES various years (Colombia and Guatemala: 2017; Costa Rica and Mexico: 2010; Honduras and El Salvador: 2016). Source: Global Entrepreneurship Monitor (2016). There is no 2016 data available for Honduras, Mexico and Costa Rica and using the latest data for all countries yielded distorted results. 199 World Bank Enterprise Survey, 2016. 98 5.3. Local entrepreneurship ecosystems in El Salvador Entrepreneurship and innovation ecosystems require many elements —on the supply side, demand side, and barriers to accumulation— to be successful. Identifying and targeting locations and industries with some existing elements can increase the effectiveness of public support policies.200 A well-functioning ecosystem facilitates the creation and survival of enterprises, as well as their growth into high potential businesses since they provide capital, workers, technology, funding sources, institutional support, customers, and suppliers to boost firms’ productivity and access to markets. Because ecosystem consist of several elements working in coordination, they require investment and time to develop. The identification of local ecosystems, including their location and industries, equips policymakers with the information to target interventions in areas with greater spillover effects and a higher probability of success. Firm-level data was used to identify local entrepreneurship ecosystems in three strategic industry groups.201 The first group is defined as high-tech entrepreneurship, which includes digital businesses and high-tech manufacturing. These industries tend to have high value-added per worker and be more innovative. The second group is tradable services (tourism, financial services, and business services). Tradable services offer opportunities for high-paid jobs and, despite being services, can be exported and benefit from economies of agglomeration. The third group is traditional sectors (agribusiness and light manufacturing), which tend to be relevant for low-skilled jobs, but also could benefit from further digitalization.202 Characteristics of the firms in each group are shown in Table 7, with more details in Annex 5. 200World Bank (2020b) 201Firm-level data comes from the Ministry of Economy’s administrative databases. The data includes the 4-digit ISIC identifier for the economic activity, the municipality where the business operates and the age of the business (the date when they first registered with the administrative authority). These records cover 23,057 firms during the period 2014-2018. Firms tend to be larger and formal, as measured in workers per firm (29.2 average), sales per firm (USD 1,703,700 average), or assets per firm (USD 2,676,700 average). 202 Digital technologies include manufacturing and repair of computers and telecommunications equipment, retail and wholesale of computers, programming activities, publishing and broadcasting activities, and data processing (Barefoot et al., 2018). High- tech manufacturing considers chemicals, plastics, pharmaceuticals, manufacturing of electronics and motors, and medical and optical instruments (Wolf and Terrell, 2016). Tourism includes accommodation services, entertainment activities, food preparation services, and air transportation. Financial services combine financial activities, insurance and pension services, and BPOs include call centers, management consulting, and administrative support activities. Agribusiness combines agriculture and food processing. Light manufacturing includes textiles, apparel, leather, wood products, and metal products (Dinh et al., 2012 and Dinh, 2014). 99 Table 7. Characteristics of businesses in the data Fraction of Fraction of Sales per Fraction of Sales per Industry women-owned total firms firm* employment worker* firms Digital technologies 4% 1.2 3% 4.5 27% High-tech 2% 2.5 4% 0.8 33% manufacturing Tourism 6% 0.8 7% 1.4 36% Financial services 4% 2.0 4% 4.6 50% BPOs 4% 0.4 5% 0.4 50% Agribusiness 6% 1.7 12% 0.6 15% Light manufacturing 2% 4.3 14% 0.5 38% */ Sales per firm and sales per worker are relative to the average plant in the data. Source: World Bank (2020b) Municipalities with significant numbers of firms in sub-sectors within the three industry groups were identified. Statistically significant agglomerations of municipalities with a high density of establishments within each 4-digit sub-sector in the industry were identified. The number of sub-sectors for which a municipality is part of an agglomeration were then counted. The indicator was then sorted into 3 broader measures of diversity: no agglomerations, agglomerations in one sub-sector, agglomerations in more than one sub-sector (e.g., both agriculture and fishing, and food processing). The potential or quality of local ecosystems was then estimated using measures of business dynamism. Data used to estimate quality included number of young firms (0-3 years), average number of workers per business, average assets per business, and average sales per worker. Municipalities were then sorted into 3 broader measures of quality: no quality agglomerations, agglomerations in one quality indicator, agglomerations in more than one quality indicator. Potential for each ecosystem is then proxied with the quality indicator. High potential ecosystems exhibit agglomerations in more than one quality indicator; maturing ecosystems exhibit agglomerations in one quality indicator; incipient ecosystems exhibit no quality agglomerations. Broad indicators of diversity (multi-sector203, mono-sector) and quality (multi-quality, mono-quality, no quality) are depicted by the shading in the maps in Figure 67. Agribusiness ecosystems are the most common in El Salvador. They are spread throughout the country, include incipient, maturing, and high potential ecosystems, and are among the businesses with the greatest share of employment. Agribusiness ecosystems with the greatest potential are in San Vicente, La Libertad, San Salvador, Cabañas, and the north of Sonsonate (Figure 67). There are few finance ecosystems, but they stand out for being the most productive and having the highest proportion of women-owned firms. The most important high potential finance ecosystems are in San Salvador and La Libertad, and two maturing ecosystems can be found in the north of Santa Ana and south of San Miguel (Figure 67). Firms in the sector generate over four times the average sales per 203Multi-sector refers to agglomerations in more than one sub-sector within the same industry, e.g. agriculture and food processing within agribusiness. 100 worker. Furthermore, finance and BPO are the only two sectors where half of the firms are owned by women, compared to average female ownership across all sectors of 31 percent. Unlike finance, the other two services ecosystems, BPO and tourism, are rare and have the lowest sales per firm. Maturing or high potential ecosystems are only found in San Salvador, La Libertad, and the south of San Vicente (Figure 67). BPO is the ecosystem with the lowest levels of sales per firm and it is followed by tourism. High-tech manufacturing and light manufacturing have the highest sales and workers per firm. Light manufacturing stands out for having over 4 times the sales per firm of the country average. Similarly, in terms of workers per firm, light manufacturing averages 215 workers, followed by high-tech manufacturing with 73 workers, whereas the average number of workers is 29. Nevertheless, the sectors have the fewest number of firms, with each accounting for less than 2 percent of formal firms in the country. Regarding their location, a significant agglomeration of manufacturing firms is found in the Center and North of the country, with high potential ecosystems in San Salvador, La Libertad and the North of La Paz, and a maturing ecosystem in Santa Ana (Figure 67). A special case are digital ecosystems. They are infrequent, highly productive, dynamic, and resilient, but dominated by men. There are a few high potential digital ecosystems, concentrated in San Salvador and La Libertad (Figure 67), but their productivity stands out. Sales per worker-hour are 4.5 times higher than the average business. These are also more dynamic: 6.5 percent of digital firms enter and 7.4 percent exit in an average year, whereas for other businesses the entry rate is of 5.1 percent and the exit rate is 6.1 percent, suggesting lower market barriers. Enterprises in the digital ecosystem also seem to be more resilient; digital firms that survived between 2014 and 2018 saw their sales per hour worked increase by 43 percent in the 5-year period, while the rest of the firms kept their productivity constant during the same period. One challenge of the ecosystem is that it is predominately controlled by men; the fraction of women-owned firms is only 27 percent. Figure 67. Entrepreneurship ecosystems in El Salvador Agribusiness Digital technologies High-tech manufacturing Light manufacturing 101 BPO Finance Tourism Source: World Bank (2020b). Identifying local ecosystems with potential is a first step toward designing more cost-effective and targeted entrepreneurship support programs. A summary of the maturing and high potential ecosystems by industry is shown in the table below. High potential ecosystems tend to concentrate in San Salvador and La Libertad. It is worth mentioning that CONAMYPE is promoting a new methodology for local economic development that integrates the participation of multiple actors, with a territorial approach. Under this methodology, the participation of the municipality gains relevance in the development of its area, assuming responsibilities that currently correspond to the Executive. 102 Table 8: Summary of maturing and high potential ecosystems across industries Industry Maturing High Potential Digital technologies San Salvador High-tech Santa Ana; Sonsonate La Libertad; La Paz; San Salvador manufacturing Tourism La Libertad; San Miguel; San Salvador Financial services San Miguel La Libertad; San Salvador BPO La Libertad; San Miguel; San Salvador Cabanas; Chalatenango;La Union; Morazan; La Libertad; San Salvador; San Agribusiness San Miguel Vicente; Sonsonate Light manufacturing La Paz La Libertad; San Salvador; Santa Ana 5.4. Entrepreneurship and innovation policies During the first half of 2020 the World Bank Group mapped the programs to support entrepreneurship and innovation in El Salvador, with the purpose of identifying potential gaps and duplication of efforts. The mapping collected data from government support programs and intermediary organizations such as incubators, accelerators, and financial institutions using survey instruments developed specifically for this purpose. These surveys collected data such as the services provided by the public program or intermediary organization, the mechanism of intervention (for example, matching grant, credit guarantee, technology extension service), the expected outcomes (entry, survival, scale up), and the target beneficiaries. They also include the budget allocation and the number of beneficiaries across regions. Information was collected from 15 government programs204 and 16 supporting or intermediary organizations between March and May 2020. The term support “instrument� is used interchangeably here with “program� or “mechanism�. It is important to highlight that in the remainder of 2020 and into 2021, the Government of El Salvador has launched multiple programs to support MSMEs to recover from the effects of the pandemic, develop the digital capabilities of local firms, and foster high potential entrepreneurships. These programs are briefly discussed below, but since they did not participate in the surveys conducted in the first half of 2020, they are not part of the detailed analyses in the rest of the chapter. 205 CONAMYPE facilitates access to financing through alliances and guarantees with the Banco Centroamericano de Integración Económica (BCIE), Banco Hipotecario, and a trust with BANDESAL. These loans are intended to ease the impact of COVID-19 on micro and informal firms. Loans are generally for small amounts (up to USD$ 10,000) and at low interest rates. Additionally, CONAMYPE has added to its offer the FECAMYPE and PROGAMYPE funds, financing mechanisms aimed at MSEs to promote 204 This includes 8 programs run by the National Commission for Micro and Small Enterprises (CONAMYPE), 4 programs run by the Development Bank of El Salvador (BANDESAL), and 3 programs run by the Ministry of Economy (MINEC). These institutions are the largest government providers of firm support programs. 205 The list of programs analyzed in this chapter is not intended to be comprehensive, but rather to present an overview of the mechanisms to promote innovation and entrepreneurship in El Salvador. 103 innovation, technology and greenfield projects under targeted programs that will be accompanied throughout the life of the loan. Moreover, MINEC recently launched several support mechanisms, including (i) e-pyme, a program to create and strengthen digital skills that enable MSMEs to sell their products and services online; (ii) the Digital Route platform, an online self-diagnostic tool that enables MSMEs to assess their digital skills and obtain recommendations to increase their technological adoption; (iii) Cloud Skills for El Salvador, to strengthen the knowledge and employability of STEM students in the technology sector—in partnership with Amazon Web Services and 14 educational institutions in the country; (iv) the "E-Lancers" pilot project to support one hundred ICT freelancers in developing skills to promote their services on global platforms; and (v) the Entrepreneurship World Cup, which seeks to foster high-potential entrepreneurships by supporting local start-ups to participate in global competitions, providing technical assistance, and linking them with accelerator programs and angel investors.206 In addition, in August 2020, MINEC-through FONDEPRO-launched a call for funds to support digital and technological services, granted co-financing through the open window modality, launched the "Recovirtiendo el Territorio" contest and the calls for its INNOVATICS I and II programs. Table 10 presents the programs, funds, and competitions of MINEC and FONDEPRO to support entrepreneurship and innovation during 2020-2021. Box 12: MINEC's strategic vision to promote innovative entrepreneurships in El Salvador MINEC's strategic vision is to promote and strengthen innovative ventures, making visible disruptive business ideas that can encourage the use of technologies in the era of digitalization. Therefore, MINEC is committed to a nascent productive sector and/or one adapted to new technologies, competitive and challenging, that develops and uses digital tools from an entrepreneurial vision. MINEC's strategic vision is developed through two approaches: (i) the promotion of innovation and entrepreneurship, in addition to applied research within companies, and (ii) support for innovation and intrapreneurship management. Regarding the first approach, MINEC aims to promote and create calls for competitive funds that promote innovation and entrepreneurship, as well as applied research within companies, providing technical assistance to both companies and entrepreneurs. Regarding the second approach, MINEC seeks to support and promote innovation management (spin-offs) within the company, as a strategy for growth and the search for new commercial opportunities in the market. Both approaches are complemented with initiatives and programs for the articulation of the innovation and entrepreneurship ecosystem. Likewise, MINEC accompanies the efforts of startups, digital startups, and spin-offs through the linkage with acceleration processes, taking advantage of the infrastructure available in the private, public and academic sectors. Source: MINEC, 2021 The analyzed government support programs aim mainly at accelerating business development, creating jobs and accessing new markets. The most common objectives of the programs are supporting the scale-up of firms and facilitating technological adoption within firms—according to interviews conducted in 2019. The most common expected outcomes are acceleration of business development, job creation and access to new markets (other expected results include incremental sales generation and new 206In parallel to the Entrepreneurship World Cup, MINEC and the Secretariat of Innovation, with support from the IDB, are working on the design and implementation of a platform to make visible high-potential digital and technological entrepreneurships previously identified by MINEC. The platform aims to connect the demand of companies operating in El Salvador with an offer of high quality local digital and technological solutions. Work is also underway to harmonize the platform with an existing platform of the Ministry of Labor (interviews with MINEC officials, 2021). 104 product development). Interestingly, technology adoption is not primarily cited as the main expected outcome, suggesting a possible disconnect between program objectives, interventions, and outcomes (Figure 68). In the case of the FONDEPRO co-financing program, although technology adoption is not an expected result, it is considered as the means through which the program's objectives, interventions and results are connected. Figure 68. Main expected outcomes of government programs Source: World Bank (2020b). Government interventions to improve “supply� factors of production concentrate on access to equipment, and less so on technology adoption and skills development. Access to equipment is supported by three (out of four) BANDESAL programs, two CONAMYPE programs, and one program (FONDEPRO) and two competitions (INNOVATICS I and INNOVAEMPRENDE) of MINEC, and it is the area which appears to have the largest budget (roughly USD 3.6 million).207 Despite technology adoption being one of the main objectives of the government interventions, only one MINEC program and one CONAMYPE program support these activities (with both seeming inappropriate budgets for such task).208 ). In the case of MINEC, this result is puzzling, since two of its mechanisms aim at increasing innovation.209 None of the institutions provide support to access electricity, water, telecommunications, or workspace (Table 9). In light of the current economic crisis due to the COVID-19 pandemic, this approach could be reevaluated, and efforts redirected to technology adoption initiatives and related skills development (see Box 13). Box 13: Impact of COVID-19 pandemic on entrepreneurship and the need for technology transformation During the COVID-19 pandemic, entrepreneurial activity has lost dynamism and ecosystem support is lacking. According to a global study of the impact of COVID-19 on startups, about 72 percent of startups saw their revenue drop since the beginning of the crisis and an average of 33 percent of jobs were cut with more than 60 percent of startups laying off employees or reducing salaries (Startup Genome, 2020). Another study (Kantis & Angelelli, 2020) found that new entrepreneurial projects in LAC have been interrupted and 75 percent of entrepreneurs report a significant decrease or stoppage in production activity, with younger firms being the most affected. Considering the specific characteristics of the current crisis, digital technology entrepreneurs have been less affected than the average. Entrepreneurs have relied on their close circle of contacts, saying that the help of 207 Budgets per type of service are difficult to determine since many programs provide multiple services and it is not possible to disaggregate budgets between them. For presentational purposes, Table 9 allocates budgets equally across services, which may result in an inflated value for managerial training, for instance, given that it is included in several programs. 208 For an illustration, see example of international best practice in Box 13 (Innovation Fund of Serbia). 209 INNOVAEMPRENDE supports the creation of new innovative firms and Innovatics promotes ICT entrepreneurship. http://industriaelsalvador.com/wp-content/uploads/2019/07/7.-Ppt-INNOVATICS-INNOVAEMPRENDE.pdf 105 support organizations has been slow and insufficient. This is particularly the case in El Salvador, Panamá, Honduras and Venezuela where about 35 to 48 percent of entrepreneurs claim lack of support. Telecommuting has been the most common response to the imposed lockdowns. However, low technical, organizational, and human capacity have limited its adoption. Almost two fifths of entrepreneurs in LAC have adopted telecommuting as a coping mechanism, followed by temporary layoffs (done by about one fifth of entrepreneurs). Another one fifth did not take any action. Entrepreneurs reported facing difficulties to implement telecommuting including the inadequacy of organization of tasks and systems, limited high-quality internet, family related concerns and commitments, and lack of computers, appropriate software, or skilled personnel. (Kantis & Angelelli, 2020.) Support organizations have also been affected by the COVID-19 induced crisis. Two thirds of supporting institutions in LAC have stopped or significantly decreased the engagement with entrepreneurs and only one fourth is optimistic about returning to pre-pandemic activity levels. The Salvadorian ecosystem is one of the most affected, together with those in Bolivia, Ecuador, Panama, Guatemala, and Venezuela. Also, it is one of the most pessimistic (together with those in Bolivia, Mexico, Dominican Republic, and Panama). Organizations face difficulties to adapt their activities to the socially distanced world. Most of the organizations have implemented online courses and webinars to entrepreneurs, but few have been able to provide closer and personalized support. One of the reasons behind this, apart from low technical and human capacity to operate online, is the lack of information about the realities faced by entrepreneurs. (Kantis & Angelelli, 2020.) In the path to recovery, innovation and technology adoption are essential for entrepreneurs as well as for the government agencies and private organizations supporting them. Facing the COVID-19 crisis has made it imperative to accelerate technology and digital transformation around the world, particularly in developing countries. As discussed in this section, current resource allocations in El Salvador are limited for technology adoption activities, despite this being one of the main objectives in existing programs. Beyond access to digital and technological infrastructure, technical capabilities need to be fostered to innovate and successfully adopt new technologies such as digitalization, data analytics, e-commerce, artificial intelligence, 3D printing, and others. Managerial and organizational skills could be strengthened so that firms can respond with flexibility and creativity to changes induced by the pandemic. Also, forward-looking guidance in new marketing and resilience strategies is needed. These changes should help accelerate economic reactivation. For instance, introducing automation and digital platforms to bring together buyers and sellers of inputs and products can reestablish disrupted value chains and reach new markets. In parallel, government agencies and supporting organization must adapt their approach. Their own digital transformation and flexibility are essential to offer appropriate and rapid responses to entrepreneurs’ needs. Finally, innovation policies to encourage collaboration between the private sector and academia could further advance the government’s Digital Agenda. Public support to address demand factors focuses mainly on facilitating market access and improving entrepreneurs’ capabilities. CONAMYPE has seven programs oriented to closing gaps in the demand side of the ecosystem (Table 9). It offers support to access national or international markets in five of its programs. Managerial and professional training for entrepreneurs (e.g., organizational skills, inventory management, marketing, human resources, business development, financial literacy) and encouraging a change of mindset in relation to entrepreneurship (e.g., attitudes towards risk) are supported by six of its programs. These interventions are generally complementary through the same programs. BANDESAL also offers managerial training and change of mindset activities in three of its programs. MINEC only provides support to market access. Within the “barriers� pillar, the main services are access to finance by BANDESAL and collaboration by CONAMYPE. All four BANDESAL programs support access to finance. CONAMYPE has 106 three programs that help strengthen collaboration and networking or promote a positive culture for women and youth (e.g., organizing networking events, mentorships; women in tech initiatives). Business education for entrepreneurship and collaborative networks are the most frequent mechanisms of intervention, followed by financial access mechanisms. All programs offered by BANDESAL provide entrepreneurship training or networking services (trade fairs, networking events, associations, digital platforms) in addition to facilitating access to finance and equipment. Likewise, CONAMYPE uses education and networking mechanisms in most of its programs. MINEC does not provide services through these mechanisms. Other commonly used mechanisms are those related to financial access such as loans, credit guarantees and equity financing. As expected from the description of services, only two programs use technology extension mechanisms, for instance, training for technology adoption, advisory for the design or building of prototypes of product or services, and only one provides early stage infrastructure and advisory, namely co-working space, incubators and accelerators (Figure 69). Figure 69. Mechanisms of intervention by public programs Source: World Bank (2020b). The offer of policies, regulations, and programs to promote entrepreneurship and innovation in El Salvador is robust in relative terms to its regional comparators. The offer of programs to support entrepreneurship and innovation in El Salvador has developed rapidly in recent years, and they have been able to adapt quickly to the restrictions and new realities imposed by COVID-19. It should also be noted that the Government of El Salvador has focused on developing strategic visions and concrete lines of action for the development of entrepreneurship and innovation in the short, medium, and long term. For example, at the beginning of 2021 the Government presented the Trade and Investment Policy 2020- 2050, which, although aimed at diversifying the Salvadoran economy and strengthening the export sector, offers strategic lines for the development of productivity and competitiveness of local firms (Secretariat of Innovation, 2021).210 Likewise, in 2020, the Secretariat of Innovation launched the Digital Agenda of El Salvador 2020-2030, a roadmap to promote the use of tools and platforms for digital identity; innovation, education and competitiveness; modernization of the state; and digital governance. (Secretariat of Innovation, 2020). 210 For example,Line of Action 4.5 "Promotion of competitiveness and internationalization of firms" contemplates the promotion of competitiveness of firms through actions that promote the level of training and qualification of workers, the accumulation of technological assets and digitalization of firms, and the promotion of collective brands, among others (Secretariat of Innovation, 2021). 107 However, important gaps and duplications in the government programs are identified. The analysis carried out during the preparation of this report finds multiple areas of opportunity to strengthen the entrepreneurship and innovation ecosystem. Very few programs offer technology extension services, early stage advisory, or support to adopt technology in general. Even though one of the most common program objectives is to facilitate technology adoption (which will allow firms to transform and grow), a government champion for the technological catch-up of firms seems to be missing. With respect to duplications, access to equipment is provided by all institutions through several programs and MINEC facilitates financial and market access, services already provided by BANDESAL and CONAMYPE. On the positive side, there is some specialization of services among provider institutions. As expected, BANDESAL is focused on removing barriers by providing financial access combined with training and access to equipment. CONAMYPE is mainly focused on demand factors (market access and entrepreneurial capabilities) that combines with networking activities and equipment access. MINEC, on the other hand, is focused on strengthening supply factors (physical and human capital). Furthermore, MINEC is working on the strategic alignment of the Business Development Plan (PLADE), for which it is consolidating a definition of roles and types of beneficiaries that each of the institutions will serve. The Government of El Salvador is making progress in strengthening the articulation between the key actors of its Entrepreneurship and Innovation Ecosystem. Aware of the coordination challenges faced by the framework of public policies for entrepreneurship and innovation in El Salvador, the Innovation Secretariat of the Presidency is working to strengthen the articulation between public institutions involved in this space (including MINEC, CONAMYPE, CNR, among others), as well as the link between government, the private sector and academia.211 For this purpose, the National Innovation Ecosystem has been developed, and within this, the Productive Innovation System (coordinated by MINEC).212 Box 14 provides an example of good international practice in terms of institutional arrangements to support innovation and entrepreneurship from the Serbia Innovation Fund. Numbers of beneficiaries and program budgets are relatively small and fragmented, and little is known about impact. Many of the support programs have very small numbers of beneficiaries, particularly for MINEC and BANDESAL programs and other mechanisms (Figure 70). While CONAMYPE has more beneficiaries per program, the 2019 budgets per beneficiary are extremely low (Figure 71). The largest programs in terms of budget per beneficiary are Banca EmprendES from BANDESAL and FONDEPRO and the contest INNOVATICS from MINEC. Banca EmprendES offers loans, loan guarantees, and business training for entrepreneurs, whereas FONDEPRO and INNOVATICS offer grants and matching grants. Desarrollo Artesanal and Un Pueblo-Un Producto offer technology extension services, but their budgets per beneficiary are $535 and $154 respectively. The low beneficiary and budget numbers suggest that government support programs are not well-positioned to meet the unprecedented firm needs being generated by the COVID-19 crisis.213 Moreover, little is known about the impact of the government 211 As part of this effort, a National Research Agenda is currently being developed, with the objective of guiding research, innovation, and technology development towards priority areas for economic transformation in El Salvador. 212 The Productive Innovation System aims to promote business productivity in industry, the private sector, large firms, as well as micro and small firms under the principles of the innovation process. The areas of work of this system include: the orange economy, investment and export promotion, e-commerce, digital transformation, skills development, business R&D, entrepreneurship and acceleration of firms, and financing. (Based on information provided by MINEC during the preparation of this study). 213 In the case of INNOVATICS I, no competitions were conducted in the 2017 - 2019 period. However, since the launch of the contest in 2013, multiple projects have been supported and new products and technological solutions have been created. It is 108 support programs, as only three programs have implemented impact evaluations. It is worth mentioning that the Innovation Secretariat of the Presidency is developing the institutional framework of the National Innovation Observatory, which will manage knowledge on innovation issues. As part of this process, a mechanism for the publication and monitoring of innovation projects and initiatives will be created. It is also contemplated to institutionalize the governance and measurement of data related to innovation, in order to contribute to the Global Innovation Index, the Sustainable Development Goals and other commitments made by the country. Figure 70. Number of beneficiaries by program Source: World Bank (2020b). also relevant to mention that in 2019 a new edition of the INNOVATICS I contest was launched, aimed at supporting technological ventures (MINEC). 109 Figure 71. Average budget per beneficiary by program Source: World Bank (2020b). Beneficiaries of public support programs are mainly concentrated in San Salvador, likely missing other ecosystems with high potential. Most of BANDESAL’s beneficiaries are located in the capital. Likewise, MINEC’s Innovatics and InnovEmprende programs only appear to serve beneficiaries in San Salvador. Although CONAMYPE covers all departments, support is still concentrated in the capital. Departments with public support presence include San Miguel, Santa Ana, La Unión, Sonsonate, Usulutan and La Libertad. As discussed in the previous section, some of these departments have local ecosystems with high potential, particularly in San Miguel, La Libertad, and north of Sonsonate, where more entrepreneurial support could prove beneficial. Supporting institutions provide important additional services to entrepreneurs, but gaps remain. Supporting institutions include research and educational organizations (some of which provide incubation and acceleration services), dedicated incubators and accelerators, advisory services providers, and industry associations.214 As shown in Table 11, supporting institutions focus their activities on the demand side of the entrepreneurial ecosystem, mostly providing managerial training and change of mindset activities. They also support collaborative and networking activities in the barrier side and human capital accumulation in the supply side of the ecosystem. However, only one institution engages in technology adoption activities. Although many of these services overlap with government program support areas, this is unlikely to be a constraint since total beneficiary numbers for all programs are low. In 2019, the mapped supporting organizations served close to 12 thousand entrepreneurs. Four organizations reported acceptance rates of 40 percent or less, suggesting that the demand for their 214 For a description of the interviewed institutions see World bank (2020b). 110 services is significantly higher than their capacity to support businesses. Similar to the government programs, support tends to be concentrated in San Salvador. Box 14: International good practice example: Serbia Innovation Fund Mission. Serbia was one of the first countries in the Western Balkans to embrace the notion that successful participation in the global knowledge economy requires the ability to adapt and advance new technological and research capabilities that involve public and private collaboration. Operational since 2011, the Serbia Innovation Fund has been a pioneering effort to operationalize and institutionalize this notion—first by increasing the capacity of startups and resources available for their growth and subsequently by implementing a broader innovation strategy. Governance. The Serbia Innovation Fund established an independent governance structure, with a robust international peer review system and a distinguished Investment Committee that includes international and diaspora professionals experienced in managing technology firms, scientific research, commercialization, and the investor community. External evaluators (two independent professional peer reviewers per application) perform the first part of evaluation/technical review, followed by the independent Investment Committee’s pre-selection decision. The final decision for financing is made by the Investment Committee at a live pitch event. Applications are accepted from all sectors, and beneficiary companies have demonstrated potential in sectors as diverse as agribusiness, construction, ICT, and bioengineering. Since its inception, 1,900 applications for innovative projects have been submitted to public calls. A total of over EUR 20 million has been approved for about 700 projects. M&E and external support. The Innovation Fund programs and operations undergo regular evaluations, from independent application reviews to a thorough internal as well as independent external monitoring and evaluation process, including awardees visits and reporting over a project’s duration and upon its completion. The fund has benefited from financing and technical assistance from the World Bank and European Commission. Fund staff have been mentored by the Investment Committee members and a strategic advisor with senior experience from Israel. They also received various trainings and participated in study visits to Israel, Finland, Croatia and the UK. Support programs • The Mini Grants Program is aimed at private young enterprises engaged in the development of technological innovations with a clear market need. This Program supports the survival of companies during the critical R&D phase. It covers a maximum of 70 percent and up to EUR 80,000 of the total approved project budget. • The Matching Grants Program is designed for enterprises looking for significant financial resources for the commercialization of research and development. It covers a maximum of 60 percent and up to EUR 300,000 of the total approved project budget. • The Collaborative Grant Scheme Program incentivizes private-sector companies and public-sector R&D organizations to engage in joint scientific R&D projects with the goal of creating new, commercially viable products and services, as well as innovative pre-competitive technologies with significant future impact and market potential. It covers a maximum of 70 percent and up to EUR 300,000 of the total approved project budget, with the 30 percent co-financing coming from the private-sector partner. • The Technology Transfer Facility (TTF) supports R&D organizations, with the aim of increasing their ability and efficiency in the commercialization of inventions. Besides providing commercialization support to academic and non-academic R&D institutions and private sector companies, the TTF can provide financial support to selected innovative projects coming from public academic R&D institutions to bring these projects to a higher commercialization readiness level. Grants can be up to EUR 50,000 per awarded project, while grants above EUR 20,000 require a commercial partner willing to commercialize the invention and co-finance at least 30 percent. 111 • The Innovation Vouchers Scheme supports SMEs who want to use services of the R&D organizations to raise their level of innovation. Each innovation voucher covers 80 percent of the total service costs, up to about EUR 7,000. • The Proof of Concept program is intended for researchers engaged in product development for which there is a need in the market. The program offers financial and mentoring support to test ideas, hypotheses or assumptions that are, if they prove technically feasible, the basis for products based on their research. The program covers 100 percent of the total cost of project, up to a maximum of EUR 20,000. The support programs were launched in phases, starting with the mini and matching grants in 2011. The other programs were rolled out during 2016–2019 after the Innovation Fund had established a solid track record of good governance and results. Source: Serbia Innovation Fund and World Bank. 112 Table 9: Main entrepreneurship services provided by government support programs, based on 2019 surveys SUPPLY PILLARS BARRIERS DEMAND PILLARS Human capital Tech adoption Market access infrastructure Collaboration Budget in Managerial equipment Changes of Regulation Access to Access to Access to mindset training finance AGENCY PROGRAM 2019 (USD) Banca Mujer - 2 2,241,900 Banca Mujer - 1 1,182,494 BANDESAL Fondo Mujer - 2 454,234 Banca Emprendes 480,763 Desarrollo artesanal 626,641 Emp femenina 87,408 Un pueblo un producto 278,000 CONAMYPE Formalización y financiera 215 Compras pública 50,000 Desarrollo proveedores 25,000 Corredores productivos 3,239,403 Acceso a mercados 50,000 InnovaEmprende MINEC Innovatics 100,000 Fondepro 3,300,000 Total Budget in 2019 (USD) 3,615,344 1,100,000 8,333 1,503,130 724,888 1,509,880 2,376,783 1,277,525 12,115,843 Source: World Bank (2020b). 215CONAMYPE has recently incorporated the FECAMYPE and PROGAMYPE funds into its offer, as financing mechanisms aimed at MSEs to promote innovation, technology, and green projects. 113 Table 10. Programs, funds, and competitions to support entrepreneurship and innovation of MINEC /FONDEPRO 2020-2021 114 Table 10. Programs, funds, and competitions to support entrepreneurship and innovation of MINEC /FONDEPRO 2020-2021 (continued) 115 Table 11: Main entrepreneurship services provided by supporting organizations SUPPLY PILLARS BARRIERS DEMAND PILLARS Human capital Tech adoption Market access infrastructure Collaboration Managerial equipment Changes of Regulation Access to Access to Access to mindset training finance INSTITUTION 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Budget in 2019 (USD) - - 203,866 82,184 10,000 2,190,048 332,438 135,264 2,741,084 2,528,367 Source: World Bank (2020 b). 116 Innovation and Entrepreneurship 5.5. Suggested Innovation and Entrepreneurship Action Plan Innovation and entrepreneurship are critical for firms to adapt (to survive) and take advantage of opportunities in the post-COVID economy. Therefore, the action plan emphasizes support measures that will facilitate firm adaptations, particularly in the short term. The action plan does not cover selected areas of the entrepreneurship ecosystem since they are outside the scope of the analysis and/or covered elsewhere. Supply factors such as infrastructure and human capital are not included. Digital infrastructure (e.g. on expanding broadband access) is covered in the World Bank’s forthcoming Digital Economy in Central America Report. Human capital issues related to the secondary, tertiary, and vocational education systems and their links with the needs of firms and entrepreneurs would merit a separate analysis. Under the barriers pillar, business regulatory environment issues (including digital readiness) are covered in Chapter 2, and broader access to finance issues (beyond specific programs to support innovative entrepreneurs) are covered in Chapter 4. Timing: Fiscal cost ST (<1 Required legal (ST): Reform Action Responsible entity year), MT change none, (>1 year) small, large Continue efforts to strengthen coordination Secretaria de between entrepreneurship ecosystem actors. This Innovación, with A. Ecosystem includes coordination within the government, as well None; decree if support from MINEC, ST None governance216 as with the private sector and academia. If needed, establish Council CONAMYPE, and an Innovation and Entrepreneurship Coordination Ministry of Education Council could be established. The Council could help 216 In El Salvador, the National Innovation Ecosystem enables the articulation of projects and public institutions for the development of innovation initiatives under 10 approaches: Productive Innovation, Social Innovation, Innovation in Health, Innovation in Science and Technology, Innovation in Education, Innovation in Public Management, Innovation in Data, Agricultural Innovation, Innovation for Employment, and Financial Innovation. The governance of the National Innovation Ecosystem is determined as follows: The Secretariat of Innovation of the Presidency is the institution that leads the process; its executive operation is designated through the Directorate of the National Innovation Ecosystem, which in turn belongs to the General Directorate of Innovation and Digital Transformation. To promote innovation in firms, the following actors are added: (i) National Innovation Observatory, as the governing body for monitoring and evaluating projects and initiatives; (ii) National Agency for Innovation, Science and Technology, as the entity that enables the creation of a favorable environment to bring business needs closer to the scientific and research offerings from academia; (iii) MINEC as a driving force for Productive Innovation through the General Directorate for Productive Innovation and Business Competitiveness; (iv) CONAMPYE, as an entity executing initiatives to develop MSMEs through modernization and innovation projects, firm incubation mechanisms and assistance; (v) PROESA, as an entity that creates a favorable environment for the development and attraction of investors, and support to emerging firms; (vi) CNR as the institution that promotes the development of intangible assets and the use of intellectual property (together with MICULTURA); and (vii) the National Agency for Innovation, Science and Technology as the governing body and promoter of the National Research Agenda and the scientific impetus (SDI). 117 Innovation and Entrepreneurship Timing: Fiscal cost ST (<1 Required legal (ST): Reform Action Responsible entity year), MT change none, (>1 year) small, large reduce fragmentation of support programs and ensure that adequate resources are channeled to the highest priorities. Strengthen monitoring and evaluation. A unit in charge of M&E could be established, e.g. in the Secretaria de Secretaria de Innovación. The unit could ensure that Innovación all firm support programs have robust M&E ST None Small National Innovation mechanisms, as well as impact evaluations for the Observatory larger programs. M&E results should then be used to adjust programs design. Clarify entity in charge of firm technology adoption. There seems to be an institutional vacuum with Secretaria de respect to promoting tech adoption. This should be Innovación ST None None filled given its importance for productivity, economic CONAPYME, MINEC transformation, and crisis recovery. Publicize new support initiatives aggressively to reach target populations, e.g. crisis-affected firms, MINEC, CONAMYPE ST None None priority sectors and value chains, young high-growth potential firms, digital services firms. Sec. de Innovacion, Leverage the diaspora by identifying mechanisms for MINEC, CONAMYPE, MT None None them to serve as investors, mentors, researchers, etc. Ministry of Foreign Affairs, PROESA Large-scale business training to micro and small firms for crisis recovery, adaptation, digitization. Although several existing programs include a training B. Firm capabilities / dimension, they lack the scale necessary to serve the CONAMYPE ST None Small training huge scale of crisis-impacted firms. Training via an online platform could cover resilience, personal initiative, costs and prices, marketing/ e-commerce, 118 Innovation and Entrepreneurship Timing: Fiscal cost ST (<1 Required legal (ST): Reform Action Responsible entity year), MT change none, (>1 year) small, large and business model transformation and innovation.217 Expand technology extension services. Begin by Secretaría de investigating the existing offer of technology Innovación, with extension services provided by supporting support from the MT None Small organizations. Then either improve / scale-up existing Secretaría de Comercio services or create a new program. e Inversiones Strengthen the linkage between the programs for the promotion of entrepreneurial culture and the productive sector, specifically, business entrepreneurship at the level of technical and technological high school graduates of the MEGATEC network. For example, consideration could be given to MINEDUCYT MT None Small appointing, for each Departmental Education Office, a technical education referent, whose duties would include facilitating entrepreneurial activities and promoting links with the productive sector of the environment. C. Business New grant and voucher programs could be adaptation, tech developed, for instance: MINEC, CONAMYPE ST None Large adoption, and • Small grants/vouchers for digitization, e- innovation grants commerce adoption 217 The training could be implemented at a large scale through a combination of online training, group learning, and individual mentoring. It could be provided entirely via smart phone, e.g. on a Facebook platform, to achieve scale at low cost and avoid face-to-face interactions (given COVID-related social distancing). The training is broadly applicable for MyPEs, and particularly well-suited for female-owned microenterprises. Possible modules include: - Resilience: Training on crisis response measures and safe reopening. - Personal initiative: Soft skills training to promote proactive, self-starting, and persistent entrepreneurial behavior. - Costs and prices: Learn how to calculate costs and fix prices to develop a new model or launch a new business that responds t o evolving customers’ needs. - Marketing / e-commerce: Training around digital marketing skills and social media, as well as selling products online and developing an e-commerce store. - Business model transformation and innovation: To respond to new customers’ needs and the new reality after COVID-19 (virtual, digital products and services). 119 Innovation and Entrepreneurship Timing: Fiscal cost ST (<1 Required legal (ST): Reform Action Responsible entity year), MT change none, (>1 year) small, large • Small grants/vouchers for measures to ensure safe business resumption, e.g. adoption of sanitation protocols • Innovation / technology adoption grants to transform production to meet new post-COVID- 19 demands Grant programs could be combined with business advisory services to maximize impact. Develop start-up grant program. This would help high-potential entrepreneurs take advantage of post- COVID crisis opportunities and combat El Salvador’s MINEC / CONAMYPE ST None Small relatively low levels of new firm entry. Moreover, most job creation comes from young firms. D. Entrepreneurship Review existing incubation and acceleration programs to see if there is substantial unserved demand. If so, investigate partnership schemes with MINEC/CONAMYPE ST None Depends the private sector and/or academia to create new programs. Study how to further strengthen local high-potential entrepreneurship ecosystems, e.g. digital technologies in San Salvador, high-tech manufacturing in La Libertad, and agribusiness in E. Local ecosystems Sonsonate. This could involve creating technology MINEC MT None Depends centers to offer extension services, laboratories for testing and prototyping, etc. Developing incubators or accelerators in selected municipalities could also be an option. Consider developing a small voucher program for F. Linkages with firms to purchase knowledge services, e.g. tech MINEC MT None Small knowledge providers advisory, mentoring, market research, assistance for patenting or licensing, testing. 120 Innovation and Entrepreneurship Timing: Fiscal cost ST (<1 Required legal (ST): Reform Action Responsible entity year), MT change none, (>1 year) small, large Consider developing a collaborative grants program Small or for joint R&D projects between firms and MINEC MT None large research/technology institutes or universities. Strengthen technology transfer services from MINEC, Ministry of MT None Small universities / research institutes to the firms Education 121 Innovation and Entrepreneurship Box 15: Innovation and entrepreneurship policies in El Salvador, 2010-2020 • National Quality Policy (2010): A guide for actions of public and private institutions related to the areas of quality, safety, continuous improvement and conformity assessment, having as its purpose the protection of consumers and the promotion of the competitiveness of the productive and commercial sectors, in harmony with the environment. • Industrial Policy (2011): aims to expand and reconvert the productive fabric, contributing to the economic growth of the country, therefore defines a horizon in the generation of processes for the development of priority industries, ventures and companies that the National Entrepreneurship Policy promotes. They will be responding to the needs of the productive sectors, providing services or goods with the potential to link up with the chains or links of the chain with high added value and technology-based. • National Policy of Science, Technology and Innovation (2012): i) Generate public goods and strengthen the enabling environment for R+D+i; ii) Create and strengthen the scientific and technological infrastructure needed for the development of STI activities; iii) Design and implement the mechanisms for financing innovative goods and services; iv) Establish regional and international alliances for the promotion of research, technology transfer and the development of R+D+I; v) Strengthen the formation of advanced human capital for scientific, technological and innovation research linked to productive development; vi) Strengthen scientific research in universities and R&D centers; vii) Develop support mechanisms for business strategies based on innovation; viii) Improve the environment and provision of financial and non-financial services. • Law for the Promotion, Protection and Development of Micro and Small Enterprises (2014): i) Establish the basis for planning and executing activities aimed at articulating micro and small businesses with territorial development; ii) Establish an inter-institutional coordination system as an instrument to support policies for the promotion and development of micro and small businesses; iii) Promote the creation of a business culture of innovation, quality and productivity; iv) Promote the facilitation and simplification of administrative procedures in proceedings with State entities; v) Promote the existence and institutionalization of business programs, instruments and services to strengthen and develop micro and small businesses, with an emphasis on those aimed at improving the situation and needs of women entrepreneurs; vi) Effectively expand the policies for the promotion and development of micro and small businesses, promoting greater coordination between the public and private sectors; vii) Promote access to services and financial resources for micro and small businesses. • National Entrepreneurship Policy (2014): Increase the capacity of response and institutional strengthening public, private and academia in the entrepreneurial ecosystem of the country, strengthening the chain of services of financing of enterprises, with innovative instruments that have a focus on gender equity and prioritize in dynamic enterprises with growth potential and the creation of an innovative entrepreneurial culture. • Law for the Promotion, Protection and Development of Micro and Small Enterprises Reformed (2018): Strengthen the role of the Governing and Executing Bodies, in order to harmonize their powers and complement them to strengthen their actions. It designated the Ministry of Economics as the governing body and CONAMYPE as the executing bodies, as well as other directions on the governance of the system. • Productive Development Strategy (2019): The general objective of the strategy is the national productive transformation that facilitates the transition to a new stage of development, pays special attention to small and medium-sized producers and entrepreneurs, stimulates new sectors, fosters associativity, and promotes innovation and productive strategies in developing territories. Its main guideline is attention to triggering initiatives, led by producers, entrepreneurs and municipalities, that respond to sustainable visions, associative strengths and productive experiences, in order to ensure the expansion of the business base and productive innovation. It also suggests taking into account value chains and the creation of new companies and their strengthening. It also considers the promotion of public- private business initiatives that promote vital projects for municipalities and their economies. 122 Innovation and Entrepreneurship • Plan for economic recovery in the context of the COVID-19 (2020): $300 transfer for lower income households; suspension of utilities bills; benefits in income taxes; tariff cuts; benefits for the payment of rents and mortgages; new exemptions of consumption taxes; $600 million for loans for micro, small, medium and large companies; $ 100 million to loans directed to the informal sector; coordinated by CONAMYPE; $ 50 million per month, while the pandemic lasts, for the acquisition of 1.7 million food packages; layoff bans; payment by the Government of 50 percent of the salary of employees of micro, small and medium-sized companies. • Digital Agenda (2020): The Agenda includes the pillars of: i) Digital Identity; ii) Digital Governance; iii) Modernization of the State, and iv) Innovation, Education and Competitiveness. https://www.innovacion.gob.sv/ 123 Participation in GVCs 6. Participation in Global Value Chains Strategic repositioning into dynamic segments of global value chains (GVCs) offers important opportunities for job creation and poverty reduction in El Salvador. Empirical evidence compiled in the World Bank Group’s World Development Report (WDR) 2020 on Trading for Development in the Age of Global Value Chains suggests that most advanced forms of participation in GVCs provide great benefits to developing countries by boosting economic growth and productivity.218 GVCs can lift average incomes and foster job creation, particularly for low-skilled workers, thus helping reduce poverty and inequality. The ongoing COVID-19 crisis could open novel opportunities for developing countries to upgrade their participation in GVCs. The potential push for diversification in multinational companies may allow suppliers from other developing countries to increase exports and participate in new segments of GVCs that previously faced intense competition from Asian countries. Recent trends in international markets offer unique opportunities for repositioning El Salvador toward more sophisticated segments of agricultural and fishing, manufacturing and services GVCs. Examples include coffee (small batch / specialty coffee), cocoa (bean to bar cocoa), seafood (ready to cook fish and shrimp), tourism (explorer /adventure tourism), and textiles (sustainable fashion). National policies play a fundamental role in ensuring that the economic and social benefits of strategic repositioning within GVC materialize. As Haven et al (2012)219, Banegas and Winkler (2019)220, and others have noted, competitiveness in El Salvador is hampered by some cross-sectoral constraints: lack of security, poor transport and logistic infrastructure, lack of industry standards and harmonization, and weak extension services. Policies and programs for supporting SMEs and value chains are heavily reliant on foreign funding and beset by inter-agency and public-private coordination challenges. El Salvador’s current participation into GVCs is marked by specialization on low value-added manufacturing products, such as textiles and other industrial goods, directed majorly to the US market. A significant portion of exports are still produced through agreements with firms based in the country under the maquila regime. However, the weight of the maquila in El Salvador's exports has declined markedly over the past decade —as firms in the maquila regime migrate to the full-package mode. According to BCR figures, in 2004 maquila exports accounted for 58 percent of El Salvador's total exports, while by 2020 the weight of maquila exports in total exports was only 18 percent.221 Participation in other GVCs also occurs in low value-added segments such as in the case of services (e.g. massive tourism and low-cost Business Processing Outsourcing or BPO) and agriculture (e.g. sugar cane and coffee). Textiles and apparel and agriculture are the main contributors to job creation, mostly through the generation of unskilled jobs. 218 World Bank Group (2019). World Development Report 2020: Trading for Development in the Age of Global Value Chains , www.worldbank.org/en/publication/wdr2020 219 World Bank (2012). Unlocking Central America's export potential. http://documents.worldbank.org/curated/en/docsearch/report/75070 220 Banegas, N. and Winkler, H. (2019). El Salvador Job Diagnostic. World Bank. Mimeo. 221 In the specific case of the textile sector, maquila exports currently represent one third of the sector's total exports (BCR and PROESA figures for 2020). 124 Participation in GVCs In addition to reviewing these common trends in participation into GVCs and barriers to competitiveness, this chapter analyzes selected value chains in El Salvador in terms of its: (a) strategic challenges; (b) international trends; and (c) areas for improvement. The current situation of each value chain is compared to an “ideal� value chain based on desktop analysis and interviews with public and private stakeholders. The chapter then presents policy recommendations for strategic repositioning of the analyzed value chains in five areas: (a) improving infrastructure; (b) fostering human capital; (c) enhancing the provision of sector-specific public goods; (d) improving market access and FDI attraction; and (e) digitalization. The remainder of the chapter is organized as follows. Section 2 presents the analytical framework and discusses recent evidence on the impacts of participation in GVCs on job creation and poverty reduction in developing countries. It also briefly assesses the challenges and opportunities created by the COVID-19 crisis for increased participation in GVCs. Section 3 delves into El Salvador’s current GVC performance, particularly in some selected agricultural and fishing, manufacturing and services value chains. Section 5 identifies the main challenges and reforms areas in the selected value chains, as well as the public policies and programs supporting SMEs and value chains in El Salvador. It also presents a suggested action plan for upgrading El Salvador’s participation in some niches of the selected GVCs. 6.1. GVCs for jobs and economic transformation This section summarizes the analytical approach for understanding the economic importance and recent dynamics of El Salvador´s participation in GVCs. It describes what a GVC is, discusses recent empirical evidence on the economic impacts of GVC participation, and analyses the determinants of GVC participation and the role of national policies. What is a GVC? A global value chain breaks up the production process across countries. Firms specialize in a specific task and do not produce the whole product (Figure 72). Figure 72: What it is a GVC? Source: WDR 2020 125 Participation in GVCs Empirical evidence indicates that participation in GVCs plays a key role in fostering productivity, growth and better jobs. Recent studies collected in the WDR 2020 show that participating in GVCs can significantly boost real incomes in developing economies, with even steeper increases in real GDP in the most advanced and innovative forms of GVC participation (Figure 73a). These positive economic effects are, in turn, largely driven by the higher productivity of firms that engage in international trade vis-à-vis inwardly-oriented companies (Figure 73b). Available evidence also indicates that advanced modalities of participation in GVCs are strongly linked with boosting local jobs and wages, particularly for low-skilled workers (Figure 73c). For example, the empirical evidence in the case of Vietnam indicates that participation in GVCs, and particularly the most advanced and innovative modalities of participation, is associated with lower poverty rates; partially, by fostering the creation of better jobs and wages. Figure 73: GVCs and growth, productivity and jobs A. Growth and participation in GVC B. Productivity and integration into GVC Note: The event study quantifies cumulated boost to real Note: The figure plots the coefficient estimates of a income growth in the 20 years following a switch from a lower regression of log of labor productivity (sales per worker) on to a higher stage of GVC engagement. dummy variables if the firm exports and imports (GVC firm), exports only, or imports only, controlling for capital per worker. The samples control for various fixed effects. C. GVC participation and job creation and wages Note: The event study quantifies the change in cumulated employment and wage growth in the 20 years following a switch from a lower level of GVC engagement to a higher level. Dotted lines indicate statistically non-significant coefficients. 126 Participation in GVCs Note: The terms "Limited", "Advanced" and "Innovation" refer to participation in limited manufacturing, participation in advanced manufacturing, and participation in innovative activities, respectively. Countries in the "Limited" category tend to export some light manufactures and raw materials. These countries exhibit an intermediate level of backward linkages with GVCs (e.g., Australia and Colombia). Countries in the "Advanced" category have high exports of technological manufactures and business services (as a proportion of total exports). These countries exhibit a high level of backward linkages with GVCs (e.g., Mexico and China). Countries in the "Innovation" category tend to invest a significant proportion of their GDP in research and development of technologies, generate a significant fraction of their GDP through intellectual property and exhibit a high level of backward linkages with GVCs (e.g., Germany and Japan). For a complete list of the categories and countries analyzed, see WDI 2020 Map 1.1 (p. 2). Source: WDR 2020. Participation in GVCs is largely driven by endowments, market size, geography, and institutions. As noted in the WDR 2020, the extent and the modalities through which developing countries participate in GVCs are determined, first, by the relative abundance of factor endowments (e.g. skilled / unskilled labor or natural resources). A second determinant is the relative size of the market, and therefore, the attractiveness of an economy for enticing market-seeking foreign direct investment (FDI). A closely related determinant is geography, and specifically, the distance to the principal export destination markets and imported input sourcing economies. Also important are access to markets and the quality of local institutions (Figure 74). National policies can enhance the benefits of participating in GVC. Notwithstanding the importance of these “fundamental� determinants, national policies can enhance the benefits of participating in GVC for developing countries. Improving access to finance, ensuring adequate labor regulation policies, avoiding real exchange appreciations, and boosting technical, managerial and advanced skills are all important. Investments in logistics and connectivity can ameliorate the restrictions imposed by physical distance and geography. Finally, engaging in comprehensive free trade agreements (FTAs) can improve access to export destinations and input sourcing markets, generating the opportunity to diversify export markets quickly.222 Participating in the latest generation of FTAs can also contribute to enhance local regulations and governance in key areas for fostering exports and FDI (e.g. standards certification, contract enforcement, policy predictability, intellectual property rights’ protection and political stability) (Figure 74). 222Both for the industries directly covered by the treaties, as well as for other productive sectors and related industries (e.g., packaging, plastics, etc.). 127 Participation in GVCs Figure 74: National policies can enhance the benefits of participation in GVCs Source: World Bank, World Development Report 2020: "Trade for Development in the Age of Global Value Chains". 6.2. COVID-19 pandemic implications for GVCs223 The COVID-19 pandemic has posed a systemic challenge to GVCs. The closing of factories, disruptions in transport, and rising concerns of essential supplies are affecting how multinational companies (MNCs) operate worldwide. As a result of the immediate supply restrictions, the demand shock and general decline in investor confidence, COVID-19 is expected to reduce FDI to developing countries by 30 to 40 percent in 2020. Additionally, the top 5000 MNCs have reduced their earnings estimates by 30 percent this year. Small and open economies are particularly vulnerable to the COVID-19 shock with suppliers to MNCs facing the largest pressures. Vulnerability to the COVID-19 shock may the highest in small economies highly reliant on international trade. Suppliers to MNCs are being specially affected by supply chain disruptions. 223Section draws on Zhenwei Qiang et al (2020), Foreign direct investment and global value chains in the wake of COVID-19. See https://blogs.worldbank.org/psd/foreign-direct-investment-and-global-value-chains-wake-covid-19. 128 Participation in GVCs However, the potential shifting of GVCs could also open new opportunities for suppliers from small economies such as El Salvador. The recent tensions between the United States and China have created incentives to MNCs to diversify their supplier base away from the Chinese market to other developing countries. The COVD-19 shock may intensify the push of global chains to diversify and regional value chains may gain more momentum. This may open new opportunities to suppliers in some small economies like El Salvador in line with its comparative advantage. Figure 75 plots non-agricultural export products in which El Salvador displays significative revealed comparative advantage (RCA) against China’s export share to the US, and to the world, in that product. The size of the bubble represents the absolute value of the product in US$ 1,000 dollars. The aim of this scatterplot is to identify some Salvadoran exported products that could benefit from the potential shifting in suppliers for MNCs away from China. Yet, seizing these potential opportunities may require an explicit strategy for repositioning and updating these sectors into GVCs. Figure 75: El Salvador’s Export Revealed Comparative Advantage and China’s Export Share to the US and the World a. United States 129 Participation in GVCs b. World Notes: The figures use 4-digit HS codes in 2018. Bubble size indicates the absolute export volume in US$ 1,000 dollars. Restricted to non-agricultural products, with Revealed comparative advantage (RCA) > 3 and a China’s export share > 4. RCA is calculated as the share of exported product i in El Salvador’s total exports as a ratio of that product’s share in world exports. Source: COMTRADE (latest data available) 6.3. Current GVC participation and performance in El Salvador This section analyses the performance of El Salvador’s participation in GVCs. First, it assesses the modalities and recent evolution of Salvadoran exports. It also presents a deep dive into selected value chains. Exports Textiles and other manufacturing products explain more than half of Salvadoran exports. Although El Salvador exports more than 1,500 products to more than 130 markets, which implies an intermediate level of export diversification (relative to Central American and Latin American partners), textiles and apparel represented roughly 47 percent of the merchandise exports in 2018, while those products explained only 38 percent of the export basket in 2000.224 Other manufacturing products (e.g. toilet paper, electric capacitors, medicaments for human and veterinary use, among others) comprise another 10 percent of total exports. Raw sugar and coffee follow as the main contributors to El Salvador’s export basket (Figure 76). 224For a more detailed discussion, see the recent El Salvador Trade and Investment Policy 2020-2050 (Secretariat of Trade and Investment, 2021). 130 Participation in GVCs Figure 76: Export Basket Composition 2000 and 2018 a. 2000 ($2.86 billion) b. 2018 ($6.12 billion) Note: Service exports not included. Source: MIT Atlas of Economic Complexity The US and Central America are the main destination markets for Salvadoran exports . The US receives around half of the exports, followed by other Central American economies like Honduras (14 percent), Guatemala (14 percent), Nicaragua (7 percent), Costa Rica (5 percent) and Panama (2 percent). The US and Central American markets are also the main destination for the principal exported products (Figure 77). 131 Participation in GVCs Figure 77: Exports by Partner Source: World Bank World Integrated Trade Solution (WITS), most recent available year Textiles and apparel contribute the most to job creation for exporting sectors. For El Salvador, while agriculture and agroindustry play an important role in job creation, textiles and apparel are the exporting sectors that have contributed the most. The contribution of those sectors to employment is mostly through unskilled jobs. Textiles and apparel also lead the generation of indirect and direct value- added in exports that proxied backward links into GVCs (Figure 78).225 Figure 78: Exports and job creation a. Top 5 sectors exporting labor value-added (USD) 225 Direct value added consists of the income paid to the production factors directly involved in exports, while indirect value added is equal to the income contained in the domestic production inputs incorporated into exports. Therefore, the magnitude of indirect value added depends on the density of domestic inter-sectoral linkages (Fujii-Gambero & Cervantes-Martínez, 2015). 132 Participation in GVCs b. Direct and indirect labor value added of gross exports (USD) Source: World Bank Exports Value Added Database (EVAD), most recent available year 6.4. Participation of El Salvador in selected GVCs The current government of El Salvador has prioritized four value chains , including artisanal fishing, shrimp fishing, agroindustry, and coastal tourism. To some extent, these are similar to the priorities of previous administrations, as they are areas in which El Salvador shows significant areas of opportunity. In October 2020, the Government of El Salvador, through PROESA, launched its new El Salvador Investment Promotion Strategy (InvestSV). Among the new sectors to be promoted under the new strategy are Textiles and Apparel, Pharmaceuticals, Packaging, Processed Food and Beverage and ICT / Creative Industry (video games) , among others.. A set of stakeholder interviews carried out by the World Bank revealed a similar set of priority sectors. Interviews conducted by the World Bank in the first half of 2019 revealed that government agencies, international organizations, and some private sector representatives shared a general perception about the value chains to be prioritized. (Note: these interviews were conducted near the end of the previous administration.) These include six value chains spanning agriculture and fishing, services, and light manufacturing, as shown in Table 12. The value chains discussed below cover a group of sectors with representative challenges and potential. These chains were selected for analytical purposes, based on interviews conducted near the end of the previous administration, and therefore do not necessarily reflect the nation's current priorities in their entirety. Similarly, the selection of these chains does not imply prioritization of these sectors and industries over other potential sectors by the World Bank. However, the study of these representative chains supports the development of an analytical basis that will be useful for the design of policies, incentives and regulations related to the sectors and industries identified by the new InvestSV 133 Participation in GVCs investment promotion strategy.226 As a complement to the general analysis presented in this chapter, it would be useful to study the challenges and opportunities for the development of productive segments and processes in the value chains in which El Salvador already has a certain degree of integration, particularly in terms of value chains at the regional level. For example, specific production processes in the textile and apparel sector.. These value chains, segments and production processes could be studied in more depth in future analytical work. Table 12: Key value chains Sector Value Chain Agriculture and fishing • Coffee • Cocoa • Seafood • Tropical Fruits Services • Tourism Light manufacturing • Apparel and knitwear • Wood • Electrical equipment Source: Secondary sources and interviews of the World Bank. Note: This briefly addresses the sugarcane value chain, but does not examine them in more detail due to the lack of attractiveness for strategic repositioning (i.e., high volume, low value products based on low labor costs). Agriculture and Fishing Value Chains Selected agriculture value chains include coffee, cocoa, tropical fruit, and seafood. Challenges and repositioning opportunities are described below. Coffee Value Chain Opportunities for strategic repositioning in the niche small batch specialty coffee segment. Considering small production volumes in El Salvador, opportunities lie in the growing niche craft specialty segment.227 Currently, coffee production is specialized in the stockable calories segment, which is a volume business.228 Craft or specialty coffee falls under the “fresh indulgence� strategic segment for final elaboration with higher prices.229 International growth trends for premium products are positive in all categories, including specialty coffees and bean-to-bar chocolate. Understanding the ideal value chain of specialty artisanal coffee is helpful to guide strategic repositioning. Small-batch craft coffee production requires the utilization of varieties of specialty coffee adapted to terroir and desired flavor, as well as fertilizers and pesticides complying with organic 226 Other high-potential emerging value chains identified in technical exchanges with the current administration includeFood and Beverage, as well as cardamom, sesame, achiote, black pepper, and sugar (raw, refined, food and beverage, and biomass). Likewise, El Salvador's National Trade and Investment Policy 2020-2050 identifies digital services value chains (such as professional software and cloud solutions) and creative industries (e.g., video games) as areas of opportunity for El Salvador's economic transformation. See (Secretariat of Trade and Investment, 2021). 227 See The Coffee Guide (link). 228 See https://www.loc.gov/cds/desktop/documents/NAL_Glosario_2009.pdf 229 Specialty coffee is not equivalent to organic coffee, which has specific production requirements. See The Coffee Guide (link) 134 Participation in GVCs certification. Its production entails the adoption of special organization practices (e.g. soil treatment, pest and weeds control, etc.) and manual harvest and grain selection techniques. Product conditioning demands selection, washing, drying at 11-13 percent humidity, and packaging. Export logistics and storage require specialized exporting companies or cooperatives that sell directly to specialized buyers, product traceability to the farm, and short storage periods with optimal humidity grade. Roasting is typically done by specialists, just before consumption, while marketing normally entails the use of sustainable packaging that guarantees short term freshness. Finally, small batch coffee is commercialized in specialty coffee shops, which are focused on the full consumption experience. These segments are supported by the provision of agricultural, technical, financial and transport and logistic services. Additionally, there are several support institutions along the value chain, encompassing research and development (R&D) organization, training providers, regulatory bodies and associations and cooperatives. Although there are high quality coffee producers in El Salvador, a significant fraction of the coffee is produced utilizing low quality varieties and harvesting techniques, while processing and distribution do not meet the most demanding international standards.230 Coffee plantations cover 7 percent of the Salvadoran territory, while more than 40 percent of coffee producers are located in the Western Region. Coffee production is characterized by the lack of soil preparation and the selection of varieties according to resistance to pests instead of quality. Harvesting tends to mix beans that are ripe and un-ripe with little or no coordination among stakeholders. Most of the production is centralized in a single processing center, using basic quality standards with insufficient washing and non-optimal drying, while storage is done is under poor humidity and temperature conditions. Exporters have to get authorization from the Salvadoran Coffee Council, who promotes the national product and connects international buyers with local producers. Coffee is mainly sold to Europe and the United States. The Ministry of Agriculture and Livestock of El Salvador has identified the multiple challenges that the coffee industry faces, and has recently launched a Plan de Despegue Sostenible del Café (Sustainable Coffee Take-Off Plan). The Plan contemplates the creation of a US$637 million trust fund (from which loans will be granted to renew 50,000 manzanas (1 manzana = 0,705 hectares) of coffee), as well as the provision of technical assistance and high quality genetic material. The Plan de Despegue Sostenible is part of the Agricultural Rescue Master Plan recently presented by the Secretariat of Trade and Investment of the Presidency and the Ministry of Agriculture and Livestock.231 230 It is worth mentioning that many coffee producers in El Salvador have the necessary quality levels to compete in international markets, even qualifying for prestigious competitions such as La Taza de la Excelencia (The Cup of Excellence). Nevertheless, a significant fraction of producers resembles the characterization presented in this chapter (e.g., limited capacity and low sophistication). 231 See (Secretariat of Trade and Investment & MAG, 2021) (link) and Diario El Salvador, see online (link). In addition to the revitalization of the coffee industry, the Agricultural Rescue Master Plan includes a Ruralization Program that considers two other strategic axes: (i) agricultural transformation for food sovereignty and (ii) ruralization. This last pillar integrates short and medium term actions to strengthen the regulatory and normative framework (implementation of the National Agricultural Policy and the Agrarian Code), institutional strengthening (modernization and strengthening of the MAG, and strengthening of the Rural Police), and the implementation of a home vegetable garden program. 135 Participation in GVCs Cocoa Value Chain Understanding the ideal bean-to-bar cocoa value chain. The bean to bar cocoa value chain offers the opportunity to move from a commodity product with unstable prices (set in London or New York) and very low margins for primary producers to niche quality products in short distribution circuits with significantly higher margins. In cocoa, for example, selling high-end fine cocoa with quality local conditioning can fetch producer prices that are 350-400 percent higher than commodity prices. Producing bean to bar cocoa requires the utilization of varieties of fine aroma cocoa adapted to terroir and desired flavors, as well as fertilizers and pesticides complying with organic certification. It also requires the adoption of organic practices in soil treatment and pest and weed control and manual harvest to carefully select the best beans. Conditioning requires fermentation with optimal temperature and humidity using small-scale machinery, drying and careful bean selection and triage. The entire production process is certified by the specialized buyer (craft chocolatiers) who also tends to provide direct technical assistance and demands bean tasting and traceability (Criscoulo et al, 2020). Manufacturing and marketing entail the elaboration of small batches, innovating in organoleptic (e.g. taste, color, odor, and feel) experiences, and combinations with spices and other ingredients. They also benefit from the use of sustainable packaging with guarantees for short term freshness and communication of traceability and organoleptic characteristics. Finally, sales are normally made through chocolatiers’ own craft chocolate shops focused on full consumer. Cocoa is produced by small growers in El Salvador under poor processing conditions, and it is exported to a few concentrated markets. Cocoa production is concentrated in the departments of La Paz, San Vicente, Sonsonate and Usulután. The total area in production is 9,147 hectares, with an average yield of 7.7 quintals per hectare and there are about 7,000 mainly small growers. Production entails little diversification of varieties of fine-scented cocoa, high use of fertilizers, and low organic production. Processing mainly involves fermentation and drying with basic infrastructure and no grain selection. Drying is done in yards, but in humid regions solar tunnel dryers or wood dryers are used. Some producers simply break the cobs and let them dry in sacks or crates, while some organizations collect grains in order to improve and unify qualities. Producer organizations establish direct commercialization contacts with commercial buyers, whereas some SMEs sell directly to consumers. The distribution to international markets is concentrated through intermediaries and wholesalers. Tropical Fruit Value Chain Understanding the tropical fruit ready-to-eat value chain. Tropical fruits are a volume business, with low margins and dominated by few global players. Over the past years import prices for bananas, for instance, have remained stable in US and EU, but agro-chemicals and pesticides costs have increased almost 200 percent and shipping costs 233 percent, squeezing margins for producers. The main international players (Del Monte, Dole and Chiquita) have profit margins of less than 2 percent. There are environmental concerns over single use plastic and other residues and the industry displays socio- economic spillovers limited to job creation. Companies specialized in the fresh tropical fruit segment (e.g. mango, melon, papaya, pineapple) have seen increases in volume of 300–1000 percent over the past 136 Participation in GVCs decade. Tropical fruits for agroindustry are, like the banana segments, a low margins business marked by high rivalry from Asian players (China, Thailand) over past decade. Like in the case of the other agricultural value chains, the ideal tropical fruit ready-to-eat chain for export to the most sophisticated international markets requires innovation in the varieties of fruit and utilization of fertilizers complying with organic certification. Production requires using qualified labor and adopting irrigation systems, harvest time control, manual harvest, maturation and pest control, cold chains and packaging. Conditioning requires thermal treatments for washing, selection, high-quality control, and sustainable packaging.232 Export and logistics involve the presence of cold chains along the entire route, frequent and personalized deliveries and service-oriented processes with long term contracts. Manufacturing is done through elaboration of small batches, innovating in product assortment, requiring sustainable packaging guarantees for short term freshness and guaranteeing traceability, high quality controls and a skilled work force. Sales entail the provision of nutritional information at the point of sale and taste and convenience guaranteed through specialized supermarkets looking for stable relationships with producers working in this niche. The production of ready-to-eat fruits is intensive in the use of technology, especially in the adoption of traceably and real time information systems. Tropical fruits in El Salvador are mainly produced by small growers using low quality processing methods and distributed through fragmented logistics networks. Small scale growers are primarily located in the western region, in the departments of Ahuachapán, La Paz and La Libertad.233 Production is fragmented, with poor sanitary practices, heavy use of fertilizers, and a lack of traceability systems. Producers also tend to use old varieties, minimum technological infrastructure, and a low skill labor force. High ready-to-eat quality requirements are not met during processing due to little control of ripening stages and minimum conditioning process, and the cold chain is not maintained throughout the process. Regarding the distribution stage, growers tend to not consolidate sales, as they generally have fixed buyers who distribute to local markets. While some growers already sell ready -to-eat produce to local markets, they do not comply with the stringent quality standards and production requirements required to participate in GVC directed to the most demanding international demand centers. Seafood products Understanding the ideal fish product value chain. Handling and extraction (from the water) require the adoption of advanced management plans, while logistics requires short and rapid distribution channels and cold chains. Conditioning and manufacturing require some minimum processing (ready to cook/eat), gastronomic innovation (e.g. recipes), alliances with specialists (e.g. chefs), industrial kitchens, sustainable packaging, high sanitary controls, and a highly skilled workforce. Export and distribution require cold chains along the entire route and frequent and personalized deliveries. Finally, sales typically involve innovative and responsible gastronomic experiences that value quality and origin, adequate 232 In the medium to long term, the value chain could be developed to encompass tropical fruit processing (e.g., preparation or preservation), generating greater domestic aggregate. However, El Salvador first needs to acquire the essential skills to efficiently produce and export ready-to-eat tropical fruits. 233 Likewise, coconut and banana production in the department of Usuluán and other tropical fruits in La Unión and El Porvenir stand out. 137 Participation in GVCs infrastructure for differentiated experiences (e.g. chefs involved in promoting differentiated fish), and retailers that value differentiated food (e.g. fresh, local and sustainable). Fish is produced in El Salvador under poor quality conditions and inadequate distribution processes. The production phase of the value chain needs to strengthen systems of extension, technical assistance, technology transfer and incorporation of good health practices, quality control, safety, and traceability. While the processing plants that sell outside and inside the country largely meet the quality requirements of the markets, products of artisan origin maintain a precarious handling and usually do not observe quality standards. The distribution phase of the value chain is characterized by inadequate maintenance of the cold chain, which is accentuated in the transport and conservation phases at points of sale, mainly in wholesale markets and even in some supermarkets (mainly for tilapia and marine shrimp). Shrimp is produced with inefficient handling practices in processing and distribution . The main obstacles for shrimp producers in El Salvador are linked to the ability to meet changing European import requirements with respect to quality and safety. Competitiveness in the processing phase is hindered by the lack of handling control practices, errors and inefficiencies in production systems, and little access to technical assistance and technology transfer. Distribution is hampered by frequent errors in the handling of the cold chain during transport from the harvest to the final consumer and low development of managerial and commercial skills. Manufacturing Value Chains Selected manufacturing value chains include apparel and knitwear, wood products and basic electrical equipment. Each has different challenges and repositioning opportunities. Apparel and knitwear Sustainable fashion represents an opportunity for El Salvador. Apparel and knitwear is a high- volume business with low margins that faces constant competition from Asian players. Considering the availability of natural fibers locally, thus, the recent experience of international firms using recycled materials in the production of their merchandise in El Salvador identifies an opportunity for repositioning toward sustainable fashion —both for large firms and SMEs.234 The ideal sustainable fashion value chain in apparel and knitwear comprises five stages: (a) fiber production, (b) spinning, weaving and dyeing, (c) design, cutting, sewing, and finishing; (d) distribution; and (e) retail. Fiber production requires adopting efficient energy and water consumption practices, improving soil health, enhancing fiber quality, preserving fiber quality, reducing use of cotton, and fostering the use of new local fiber products such as hemp and cactus. Spinning, weaving and dyeing demands less consumption of water and efficient energy consumption, eutrophication and acidification, zero discharges of hazardous materials, and the use of natural dyes such as walnut shells, while larger firms have made progress in developing capabilities for 234For example, the case of the EcoSmart garment line of Hanes Brands in El Salvador. The sewing plants use recycled plastics as the basic material to make the garments of the EcoSmart line, which has enabled the recycling of the equivalent of 450 million plastic bottles (PROESA, 2021). 138 Participation in GVCs the sustainability of these processes, SMEs show significant room for improvement in this area.235 For distribution, sustainable fashion entails the use of redesigned packages, increased rail shipping, less polluting transport, and agile logistics to different points of sale. Retail involves the adoption of energy efficiency and renewable programs, the use of social media, the development of “smart products�, a nd - e-commerce. Apparel and knitwear producers in El Salvador specialize in a few low value-added and products adapted for the US export market. Local companies mainly import materials (which can be semi-finished) from foreign contracting companies without using local fibers or incorporating local R&D. In terms of processing, Salvadoran companies specialize in producing large volumes of a few goods under rigid organizational schemes with little flexibility of the workforce. Finished or semi-finished products are exported to companies abroad. There is little local participation in logistics and retail and Salvadoran companies do not develop their own digital strategies. Wood products Increasing sustainability also holds promise for wood products. Wood products face environmental concerns regarding exploitation of natural resources (e.g. trees) and impacts on water sources (e.g. bleaching process for toilet paper). Opportunities for strategic repositioning lie in producing other on-trend paper products with lower environmental impacts, such as corrugated paper packaging, and developing the timber value chain. Regardless, the value chain needs to impose proper legislation to ensure correct resource management. The global demand for environmentally friendly wood products grew by 5 percent annually between 2010- 2016, reaching about $14 billion. There are opportunities for developing eco-friendly fibers for textiles and packaging products in association with global companies (e.g. Spinnova). The competitiveness of wood production in El Salvador is hampered by logging for other industries, informality and high transport costs. El Salvador’s forest area was reduced in past decades due to massive logging to produce indigo, coffee, cotton and sugar cane. Informality in the sector of sawmills and furniture factories, doors and parts, as well as high competition with portable sawmills and illegal wood, leads to a decrease in the selling price of wood in the processing stage of the value chain. Inadequate road infrastructure translates into very high transport costs. Local producers lack direct contact with final markets. Basic electrical equipment Basic electrical equipment is an industry with limited value creation, mostly focused on low- cost labor. Export production is concentrated in few companies. Opportunities for strategic repositioning largely lie in adding value upstream (e.g. R&D). Basic electrical equipment products in El Salvador are mainly wire harnesses for passenger vehicles for the North American automotive industry. Companies have been attracted by the relatively low-cost and trainable workforce, tax incentives, favorable rules of origin, and proximity to the client market. There is little local value-added. In spite of their relative 235This paragraph refers to the elements that must be improved in order to develop the sustainable fashion segment. Currently, dyeing and knitting processes in El Salvador, particularly among SMEs, have high levels of energy and water consumption, as well as high discharges. 139 Participation in GVCs significance in the export basket in El Salvador, basic electrical equipment is produced under traditional maquila schemes by subsidiaries of US-based multinational companies. Services Value Chains Selected services value chains include tourism and business process outsourcing (BPO). Although they are not analyzed in this study, it is worth mentioning that, in addition to tourism and the outsourcing of business services, others value chain with development potential correspond to digital services (animation, video games, application and software development) and technology services (ITO). El Salvador has a growing base of local firms (mostly SMEs) that have the capabilities to provide these services; some of these firms are now exporting their services. Some BPO firms have even recently begun exporting information technology outsourcing services (ITO). Tourism International tourism in El Salvador had made significant progress in the years prior to the pandemic. However, due to the international crisis and the measures that the Government of El Salvador has taken to control the contagion of COVID-19, tourism flows have practically halted (as in most of the world).236 However, the country has unique natural assets for adventure tourism aimed at millennial generation, who tend to have greater acceptance of moderate risks and look for uncharted destinations. Similarly, El Salvador has an important comparative advantage in terms of air connectivity, which facilitates the development of the international tourism value chain. Adventure and eco-tourism also have potential for significant socio-economic impacts in under-developed regions. Moreover, adventure tourism is likely to be one of the earlier tourism segments to recover from the COVID-19 crisis given that it tends to attract less risk-averse and younger travelers and may be more suitable for outdoor and socially-distanced pursuits. This report focuses on adventure tourism because of the potentials mentioned above, but this is not the only high potential segment in El Salvador; other segments that would be worth studying in depth in the future are beach tourism and medical tourism, segments that have been prioritized in the national investment attraction strategy. Changes in global tourism demand could constitute an opportunity for El Salvador. Explorer / adventure tourism is one of the most dynamic segments of international tourism. The global adventure market is estimated to be worth between $683 billion (ATTA, 2018) and $745 billion (IFC, 2018). According to ATTA (2018), it shows a 21 percent cumulative annual growth rate (CAGR) since 2012. USAID (2018) estimates this segment produces 4.5 times more income and twice the employment of mass tourism (USAID, 2018). This type of tourist aims to collect rare, customized, and authentic experiences. Such tourists are also interested in “giving back�, including through eco-friendly and socially responsible activities. Likewise, tourist operators in this segment often use ICT tools intensively for direct marketing of their services. By initiating an orderly reopening of the Tourism Sector at the national level—even with 236 According to data from the Salvadoran Tourism Corporation, CORSATUR, the tourism industry in El Salvador registered significant growth prior to the pandemic: international visitor arrivals and tourism spending in 2019 was 2.6 million visitors and USD 1, 761 million, respectively; the latter equivalent to a 15 percent increase over 2018 tourism spending. Likewise, in the January-February 2020 period, a 7.1 percent growth in international visitors was obtained, tourism expenditure reported an increase of 23.4 percent, compared to the same period in 2019. Information provided by MITUR during the feedback rounds of this report. 140 Participation in GVCs the COVID-19 pandemic—El Salvador has an opportunity the opportunity to reposition the tourism sector towards higher value and lower risk segments through exploration or adventure tourism, ecotourism, scientific tourism, birding tourism, nature tourism, cultural tourism in open spaces, geotourism and other outdoor tourism. The ideal value chain of explorer tourism includes three stages: (a) pre-trip, (b) during trip, and (c) post-trip. The pre-trip segment requires information readily available online. Decisions on reservations are often made while scouting for information, and therefore should be immediately actionable. Regarding inbound logistics, trips needs to be biosafe and reliable to avoid wasting time. During the trip, local attractions should to be highlighted and made accessible for the tourist to experience “controlled authenticity�; and experience formats should to be regularly reviewed. Accommodation and food should to be eco-friendly and highlight local uniqueness. Incorporating domestic tourism into the value chain of the Tourism Sector will once again play a key role in the post-COVID-19 reopening, and generating the conditions for domestic supply and demand to generate synergies and sales will be fundamental. Finally, post-trip online reviews and feedback should be promptly addressed. CRM databases should be used to encourage repeat visits with new experiences. For explorer tourism in El Salvador, information is not readily available, the service offering is heterogeneous, and there is limited visitor feedback. National promotion institutions have insufficient data collection methods and do not disseminate the market analyses needed by tourism businesses. During the trip, destination service offerings are not well differentiated, and there are no minimum quality standards. El Salvador also has relatively poor infrastructure, which limits accessibility, decreases security, and increases costs. Natural and cultural assets are presented in a traditional way, with only anecdotal information provided to customers to value the experiences that can be derived from them. The use of digital resources to market and disseminate information on those assets is limited as well as the adoption of non-traditional experiences and events. Post-trip, there is limited visitor feedback, and hence, the tourist returns largely more due to the inertia of business than to an active retention strategy. Business Process Outsourcing (BPO) While El Salvador exports more BPO services than Guatemala and Honduras, the country is placed well behind the principal Spanish speaking BPO exporters in Latin America. BPO is a volume commodity business based on providing services that are outside of clients’ core businesses. Competition is global and based on the cost of unskilled labor. BPO creates limited socioeconomic spillovers based on unskilled job creation. El Salvador is the sixth largest exporter of BPO services in Latin America and the Caribbean, with $73 million in exports in 2017, compared to $1,163 million Costa Rica (Figure 79). 141 Participation in GVCs Figure 79: BPO services exports - top 10 Spanish-speaking countries (USD million) Source: WTO (latest available year) El Salvador is a 2.5 hour flight from the US market and in an attractive time zone. Approximately 85 to 90 percent of BPO exports are directed to the US. The country offers competitive pricing with respect other Latin American BPO centers. BPO operators are also likely to display a better understanding of the US customer, partly due to the presence of the large Salvadoran diaspora in the US, and its strong ties with the local population. BPO companies also can benefit from generous tax incentives (e.g. duty-free imports of BPO-related equipment and furniture and income tax exemption) and location in services parks. The low wages of bilingual BPO agents increase El Salvador's cost competitiveness, but reduce their impact on the local economy, so it is essential to develop more value-added jobs. Wages in El Salvador for ICT and ICT-enabled services jobs are in the bottom half of the Central American region, making it an attractive destination for FDI in the region. El Salvador's hourly rates are lower than the rates in Costa Rica and the United States, its main export target market. The labor cost of a bilingual BPO agent in El Salvador is 36 percent lower than in Costa Rica ($4.12 in El Salvador compared to $6.4 in Costa Rica). The labor cost of junior software in El Salvador is 19 percent lower than in Costa Rica and 38 percent lower than in the United States ($11.44 in El Salvador compared to $14.21 in Costa Rica and $18.49 in the United States).237 Upgrading for El Salvador´s BPO sector is hampered by the lack of connectivity infrastructure, limited English proficiency and migration outflows in skilled labor . This lack of connectivity is reflected in overall internet penetration: El Salvador ranks very low not only in LAC, but also among countries at the same level of development. The country ranks 13 out of 19 among the LAC countries in english proficiency and 60 out 100 countries/regions worldwide238. According to Banegas and Winkler (2019), adult Salvadorian migrants in the US are 20 percentage points more likely to have a high-school diploma than 237 World Bank (forthcoming), Central America Digital Economy: Enabling Environment Assessment . Based on data from GDP Global (2018) and payscale.com. 238 https://www.ef.edu/epi/regions/latin-america/el-salvador/ 142 Participation in GVCs their counterparts at home, and one percent more likely to have a college degree. In addition, the improvement of the BPO sector requires the strengthening of other competencies and qualifications in the workforce, such as technological skills (e.g., programming) or training in languages other than English. 6.5. Main challenges and reform areas Based on the above comparisons between the ideal and current value chains in El Salvador, this section identifies missing segments and potential coordination failures in the some of the prioritized value chains. It also analyses existing government programs to identify policy gaps and potential synergies and overlaps. Finally, it presents detailed policy actions for strategic repositioning in some of the value chains. While the previous section presents some preliminary analysis for the sugar cane and basic electrical equipment value chains, this section does not pursue them further due to lack of attractiveness for upgrading (e.g. high-volume, low-value commodity businesses based on low labor costs). In the cases of the BPO, wood and the seafood products value chains, in contrast, further field research would be needed to present precise policy recommendations. Missing segments and potential areas for improvement Agricultural and Fishing Value Chains To penetrate the specialty coffee segment, El Salvador needs to boost investment in innovative varieties, organic certification and practices, traceability, and direct sales to specialized buyers . To reposition the value chain into the specialty small batch segment, El Salvador needs to boost investment in R&D for developing coffee varieties adapted to terroir and desired flavor. Pesticides and fertilizers should be adjusted to comply with organic certification. In the production and harvesting stages, training for growers is needed on organic practices (e.g. soil treatment, pest and weed control, etc.) and specialized manual harvesting. Regarding processing/conditioning, El Salvador needs better facilities and training for washing, drying and packaging and packing. In the export and logistics stage, training would be needed for cooperatives to sell directly to specialized buyers. ICT systems would also be needed to guarantee traceability from the farm and improve logistics. El Salvador’s cocoa value chain needs to undertake a multidimensional strategy to upgrade into the bean-to-bar segment. Like in the case of small batch coffee, upgrading into the high value bean-to- bar segment requires investing in R&D for identification of fine cocoa aromas best adapted to terroir. Coordination with other growers in Honduras and Guatemala could also help improve variety. Shifting toward the use of organic pesticides and fertilizers could also facilitate upgrading. In the production and harvesting stage, strategic repositioning would require training in organic practices and manual harvesting for optimal fruit bean selection. Similar to coffee, training to cooperatives on how to sell small batches directly to select buyers, sustainable packaging and packing training, ICT systems for traceability, and improved storage facilities and logistics (to reduce storage periods) would also be beneficial. To upgrade into the ready-to-eat tropical fruit segment, El Salvador needs to identify new varieties, improve production and harvesting techniques, and enhance export logistics. New varieties could be identified to keep up with international trends, and organic pesticides and fertilizers and smart irrigation systems adopted. Other areas for improvement include labor training, harvest timing, quality 143 Participation in GVCs management, maturation control and ripening facilities, washing treatments, cold chain management, and sustainable packaging and packing. Manufacturing Value Chains Upgrading apparel and knitwear toward the sustainable fashion segment, and develop capacities for sustainable spinning, knitting and dyeing by SMEs in the industry. R&D investment to develop new local fibers (e.g. hemp, cactus) and improving energy and water efficiency during fiber production would be beneficial. In the stage of spinning, weaving and dyeing, improvements would be needed in energy and water management, eutrophication and acidification, discharge of hazardous chemicals, and use of natural dyes such as walnut shells. In design, cutting, sewing and finishing, competitiveness could be improved through training in fast fashion design activities, energy efficiency, and better labor practices. Distribution requires more agile logistics to different points of sale. In retail, local companies would need digital training for use of social media and digital marketing and e- commerce.239 On the other hand, SMEs have significant room for improvement in terms of developing capacities for sustainable spinning, knitting and dyeing of garments. In addition to enabling efficiency gains, strengthening the sustainable production capabilities of SMEs would contribute to developing a robust sustainable fashion chain in the country. As indicated in the National Trade and Investment Policy 2020-2050, efforts to attract foreign investment in segments that more intensively incorporate skilled labor and digital technologies (e.g., design and apparel) play an important role in the transformation of the nation's export matrix (Secretariat of Trade and Investment, 2021). Services Value Chain Upgrading to serve tourists in the explorer/adventure segment. In the pre-trip stage, online presence, marketing, and reservation systems could be improved, including through better public-private coordination. Digitization is particularly important in light of the COVID-19 crisis, given that travelers may want more information on safety protocols prior to a trip, as well as to conduct more transactions online prior to and during trips. Improving regional connectivity to develop regional synergies would also help (particularly in the eastern part of the country). In the "during the trip� stage, technical assistance could be provided to local operators to highlight unique natural, cultural and historical assets and structure tourist experiences. Given the COVID-19 crisis, developing and implementing “safe tourism� certifications may also be considered, as could modifications to tourist sites and facilities to permit social distancing. Appropriate accommodations and food and beverage options are also important. Post-trip there is need to provide training on digital marketing and CRM to local operators to capture traveler feedback and reviews. Once the restrictions on international mobility imposed by COVID-19 pass, segments such as beach tourism, medical tourism, and congress and convention tourism will be interesting bets that could complement the offer in the ecotourism, exploration, and adventure segments (see Secretariat of Trade and Investment, 2021). 239 As mentioned in chapter 2 of this report, digital commerce is critical for the development of SMEs in El Salvador. In particular, it is necessary to formalize the transactional structure of e-commerce in the country to facilitate purchases from the United States, the main destination for manufactured goods exports. 144 Participation in GVCs Public policies and programs supporting MSMEs and value chains El Salvador’s trade promotion and productive development policies are coordinated by the Ministry of Economy. Five main public agencies are involved: Ministry of the Economy, the National Commission for Micro and Small Enterprises (CONAMYPE), the Agency for the Promotion of Exports and Investment (PROESA), the National Commission of Science and Technology (CONACYT). Regarding agricultural policies, the main agencies are the Ministry of Agriculture and Livestock (MAG), Ministry of Environment and Natural Resources (MARN), and National Center of Agricultural and Forestry Technology “Enrique �lvarez Córdova� (CENTA). In the specific case of trade policies, the most recent was the Trade and Investment Policy coordinated by the Secretariat of Trade and Investment, with the support of institutions such as MINEC, PROESA and CONAMYPE. Many of the activities for the promotion of trade and SMEs are funded by loans from international organizations and technical cooperation resources. The principal program for supporting value chains is funded by US$ 6.2 million loan from the Interamerican Development Bank (IDB). Its aim is to provide technical assistance and financing to specific value chains: agroindustry (fruits, vegetables and milk products) and tourism. Potential areas for improvement of the program highlighted by local stakeholders include balancing the current focus on individual producers with more focus on broader projects that support the whole value chain, as well as improving coordination with other agencies such as PROESA and CONAMYPE. Policy efforts are fragmented in multiple programs, often with similar goals, that reach a small number of companies. For instance, the Ministry of the Economy has various support programs (including, FONDEPRO, Innovatics, InnovaEmprende) that appear to have reached only 74 beneficiaries in 2019. CONAMYPE has another 8 micro and small enterprise support programs that reached about 6,000 beneficiaries in 2019. Private agencies play an important role in SME promotion and value chain support with little coordination between public and private organizations. The Chamber of Commerce of El Salvador has a wide offer of programs for SMEs and export promotion. To some extent, the Chamber appears to be offering export promotion services that competes with PROESA’s, and there seem to be no coordination between public and private efforts. Box 16: International good practice example: Upgrading into GVCs—medical devices in Costa Rica Costa Rica offers an excellent example of a successful upgrading strategy into more sophisticated segments of GVC in a developing country. With the aim of moving away from low-skill manufacturing (mainly in apparel), the Costa Rican government launched a comprehensive set of measures aimed at penetrating the markets of some high-technology products. Medical devices offer a prime example of this effective strategy. The international evidence indicates that the development of this industry requires four conditions: the presence of a highly-qualified workforce, regulatory alignment with demand markets given the health-sensitive nature of these products, attracting suitable foreign suppliers and /or developing local providers of critical parts and components, and efficient trade and investment policies. 145 Participation in GVCs Since 1990s, the Costa Rican government implemented a four-pronged policy strategy aimed at improving the country’s competitiveness in these four fronts. First, while Costa Rica is not the lowest cost source of labor, skilled workers are drawn from technical school graduates and specialized university programs (e.g., material handlers, engineers, and microbiologists). Second, the country has been successful in attracting foreign suppliers that already possessed the specialized management techniques and technologies required for producing medical devices. Third, fabrication of medical devices entails complying with stringent regulatory requirements, particularly in high-risk devices. In Costa Rica, local firms are increasingly engaging in the production of these more demanding products. Also, the Latin American headquarters of the US Food and Drug Administration (FDA) located in San Jose in 2011, facilitating access to information on regulations and allowing regulatory coordination with local authorities, firms and associations. Finally, Costa Rica has a unique institutional framework for investment attraction led by the Costa Rica Investment Promotion Agency (CINDE), a private, non-profit organization. CINDE coordinates its activities with other non-governmental and governmental agencies, enjoying high level support and providing high-quality assistance to investors along the entire investment cycle. As a result of these efforts, Costa Rica has been extremely successful, achieving a more than ten-fold increase in medical devices’ exports. It has also been able to foster an increasing sophistication of its export basket towards more complex devices such as medical and surgical instruments, therapeutic devices and diagnostic equipment. Source: World Bank (2019). World Development Report 2020: Trading for Development in the Age of Global Value Chains. 6.6. Suggested GVCs Action Plan Fiscal Timing: cost ST (<1 Required Responsible (ST): Reform Action year), legal Entity none, MT (>1 change small, year) large - Assign entity responsible for coordinating value chain development within the government and with industry representatives (in the proposed Trade and Investment Policy 2020-2050, such entity would be the Productivity and Competitiveness Cabinet, under the Secretariat of Trade and Investment). - Identify and implement short-term measures to A. Ministry of stimulate recovery of selected GVCs (examples for See Institutional Economy and ST, MT None tourism below) below coordination others - Identify / validate key interventions for medium-term strategic repositioning of selected GVCs (the list below could be used as a starting point, and should be aligned with the priorities identified in the Trade and Investment Policy 2020-2050). - Coordinate with public and private stakeholders to implement selected interventions - Specialty coffee: improved facilities for washing, MAG MT None Large drying and packaging B. Improving - Bean-to-bar cocoa: improved storage facilities and infrastructur MAG MT None Large logistics to reduce storage periods e - Ready-to-eat tropical fruit: improved maturation MAG MT None Large control and ripening facilities 146 Participation in GVCs Fiscal Timing: cost ST (<1 Required Responsible (ST): Reform Action year), legal Entity none, MT (>1 change small, year) large - Sustainable fashion: (a) improvements in energy and water management, eutrophication and acidification, Ministry of and discharge of hazardous chemicals during spinning, Economy/ MT None Large weaving and dyeing; and (b) more agile logistics to MARN/ CNE different points of sale in distribution. - Explorer / adventure tourism: improving regional connectivity to develop regional synergies and Ministry of supporting the development of appropriate Economy accommodations and food and beverage options. In ST/MT None Large /PROESA/ the short term, visitor management protocols could be MITUR implemented in tourist sites to permit social distancing in light of COVID-19. - Specialty coffee: (a) training for growers on organic practices (e.g. soil treatment, pest and weed control, MAG / MARN/ etc.), specialized manual harvesting and washing, ST None Small PROESA drying and packaging; and (b) training for cooperatives on how to sell directly to specialized buyers - Bean-to-bar cocoa: (a) training in organic practices and MAG / MARN/ C. Fostering manual harvesting for optimal fruit bean selection; and Universidad de ST None Small human (b) training to cooperatives on how to sell small El Salvador capital batches directly to selected buyers. - Ready-to-eat tropical fruit: training on harvest timing, quality management washing treatments, cold chain MAG MT None Large management, and sustainable packaging. - Sustainable fashion: training in fast fashion design Ministry of activities, energy efficiency, and better labor practices Economy/ ST None Small in design, cutting, sewing and finishing. CONAMYPE - Specialty coffee: (a) investment in R&D for developing coffee varieties adapted to terroir and desired flavor; CENTA/ MAG MT None Large (b) adjust pesticides and fertilizers to comply with organic certification - Bean-to-bar cocoa: (a) investment in R&D for identification of fine cocoa aromas best adapted to terroir; (b) coordination with other growers in CENTA/ MAG MT None Large Honduras and Guatemala to improve variety; and (c) D. Enhancing promoting the use of organic pesticides and fertilizers. the provision - Ready-to-eat tropical fruit: (a) identification of new of sector- varieties to keep up with international trends; and (b) CENTA/ MAG MT None Large specific promoting adoption of organic pesticides and public goods fertilizers and smart irrigation systems - Sustainable fashion: R&D investment to develop new CONACYT MT None Large local fibers (e.g. hemp, cactus) - Explorer / adventure tourism: technical assistance to local operators to highlight unique natural, cultural Ministry of and historical assets and structure tourist experiences. Economy/ ST/MT None Small In the short-term, the government could develop a CONAMYPE/ “safe tourism� certification program and help tourist MITUR facilities get certified (in light of COVID-19). E. Improving - All value chains: improved access to destination market markets and attraction of FDI in the targeted segments PROESA/ CSC MT None Small access and (see Action Plan in chapter 3). 147 Participation in GVCs Fiscal Timing: cost ST (<1 Required Responsible (ST): Reform Action year), legal Entity none, MT (>1 change small, year) large FDI attraction - Bean-to-bar cocoa: improved ICT systems for CENTA/ MAG MT None Large traceability Ministry of - Sustainable fashion: digital training for use of social Economy/ ST None Small F. media and digital marketing and e-commerce in retail CONAMYPE Digitalization - Explorer / adventure tourism: (a) improved online Ministry of presence, marketing and reservation systems Economy/ (particularly given COVID-19); and (b) training on ST/MT None Small CONAMYPE/ digital marketing and CRM to local operators to MITUR capture traveler feedback and reviews 148 Annexes Annex 1: Full list of growth, jobs, and MSME subjects and report coverage Subject Covered in report / rationale for not including LABOR DEMAND: FIRMS Firm capabilities and behavior • Innovation Yes • Technology adoption Yes • Entrepreneurship Yes • Exporting Part of GVC chapter. Export diversification also highlighted in Unleashing C.A.s Growth Potential Diagnostic • Forward/backward linkages Yes (FDI chapter) Enabling environment • Investment policy and promotion Yes • Access to finance Yes • Regulatory environment / institutions Yes. Corruption not covered directly but highlighted in Unleashing C.A.s Growth Potential Diagnostic • Standards and quality infrastructure No. Could be subject for future analysis • Trade policies No. Could be subject for future analysis • Trade facilitation / logistics Yes • Physical infrastructure (road/air/sea A few issues highlighted under trade facilitation in connectivity, ICT, electricity) business environment chapter, but largely outside of scope. • Macro and fiscal stability and sustainability No, outside of scope • Crime and security No. See Jobs Diagnostic and Unleashing C.A.s Growth Potential Diagnostic LABOR SUPPLY: WORKERS Skills No. See Jobs Diagnostic and Unleashing C.A.s Growth Potential Diagnostic Labor participation, including female, youth, No; see Jobs Diagnostic rural population, migration Labor market regulations, including hiring, No; see Jobs Diagnostic firing, and other regulations; non-wage labor costs Health No; beyond scope SECTORAL POLICIES • Manufacturing Some coverage in GVCs chapter • Tourism Some coverage in GVCs chapter • ICT Digital services highlighted in Innovation chapter. See also forthcoming Digital Dashboard. • Agriculture and fishing Some coverage in GVCs chapter 149 Annexes Annex 2: WBG Jobs and Economic Transformation framework Note: Areas covered by this report are shown in blue bold text in the bottom row. Better Jobs for More People Job-Creating Private Economic More Productive Workers Investment Transformation & Entrepreneurs Connecting to and creating markets Building capabilities & connecting workers to jobs Expanding Enabling Macro Strengthening access to Adopting sectors: Entrepreneurship Labor markets and Human capital- foundations Trade and business competitive technologies Finance and MSME active labor Social protection education, health and integration enabling and to raise and growth market policies institutions environment contestable productivity infrastructure markets Source: Authors’ elaboration, IDA Special Theme JET paper May 2019, and Development Committee Paper on JET October 2019. 150 Annexes Annex 3: World Bank COVID-19 El Salvador enterprise survey results The World Bank conducted an enterprise survey in El Salvador to measure the impact of COVID-19 on the private sector. The survey was a follow-up to the World Bank’s standard enterprise survey conducted during 2016 in El Salvador. This enabled it to combine baseline data collected before the pandemic with data collected during the pandemic. The table below summarizes the main findings from the follow-up survey. Business owners and top managers of 719 firms were interviewed for the 2016 standard survey, and the same firms were re-interviewed for this COVID-19 survey between June and August 2020. All Small Medium Large Manufact- Service Firms Firms Firms Firms uring Firms Firms Operations Percent of firms confirmed 1.3 1.1 1.9 0.9 2.4 1.0 permanently closed Percent of firms confirmed or 29.5 24.5 41.9 39.5 32.8 28.7 assumed permanently closed Percent of firms confirmed 0.2 0.2 0.3 0.0 0.9 0.0 permanently closed since COVID-19 pandemic declared Capacity utilization (%)* 31.7 20.9 42.6 46.4 31.7 n.a. Percent of firms that started or 32.4 33.3 34.1 20.5 20.1 35.6 increased online business activity Sales Percent of firms experiencing 85.3 86.1 83.3 83.0 86.7 84.9 decreased monthly sales compared to one year ago If decreased, average percent drop in 72.0 76.0 60.8 62.2 71.6 72.1 monthly sales compared to one year ago Average change in monthly sales -56.6 -59.7 -49.2 -47.3 -58.8 -56.0 compared to one year ago Workforce Percent of firms that decreased total 90.0 92.5 84.7 80.0 87.0 90.8 hours worked per week Percent of firms that decreased the 46.3 47.5 49.1 29.7 45.1 46.7 total number of permanent workers Percent of firms that decreased the 34.9 38.3 23.4 29.0 36.2 34.5 total number of temporary workers Finance Percent of firms experiencing 82.8 83.6 83.5 74.2 87.2 81.7 decreased liquidity or cash flow availability Percent of firms delaying payments to 67.3 67.6 69.9 57.8 71.6 66.1 suppliers, landlords, or tax authorities Percent of firms that are overdue on 28.4 32.7 22.0 6.4 33.2 27.1 obligations to financial institutions Gender Proportion of female workers taking 36.0 36.3 39.4 25.3 51.5 32.4 more than 5 days of leave or quitting 151 Annexes All Small Medium Large Manufact- Service Firms Firms Firms Firms uring Firms Firms Proportion of female workers among 25.6 18.9 39.9 24.3 38.6 23.8 the workers laid off Percentage point change since ES in 1.1 1.4 0.5 -1.1 3.9 0.3 prop perm full-time workers that are female Policy Percent of firms that received 3.1 1.7 8.1 3.1 4.9 2.6 national or local government assistance Percent of firms that expect to 9.2 10.6 3.7 9.6 18.9 6.7 receive national or local government assistance Percent firms that received/expect to 12.3 12.3 11.9 12.7 23.8 9.3 receive national or local govt assistance Expectations Percent of firms that anticipate falling 44.8 48.6 42.1 16.0 47.2 44.1 in arrears on outstanding liabilities Percent of firms that do not expect to 0.0 0.1 0.0 0.0 0.2 0.0 ever return to the normal level of sales Number of months that firms expect 5.2 5.4 4.3 5.6 4.0 5.5 will take to return to normal level of sales Number of months firms expect will 1.9 2.1 1.3 1.4 2.2 1.8 take to return to normal level of workforce * These indicators are computed only for the manufacturing sector Note: the size and sector information used in the breakdowns are from the baseline Enterprise Survey (2016). Note: unless explicitly mentioned, the data in this table are presented in relative terms (percentages). For more information on the survey visit http://www.enterprisesurveys.org 152 Annexes Annex 4: FDI comparator peers’ selection Structural comparator countries were generated via an automated comparator selection tool which finds similar countries along the following dimensions: GDP per capita, total population, natural resource rents (percent of GDP), Human Capital Index, Economic Complexity index, and industry employment share. Aspirational countries were selected based on the indication of a GDP/capita at least double the value of El Salvador. It is assumed that for aspirational purposes, the country’s benchmarks are economies w ho are at least twice as rich. The following list includes the structural, aspirational, and regional comparator countries: • Structural peers: Average of the Dominican Republic, Honduras, Armenia, Bosnia and Herzegovina, Georgia, Serbia, and Tunisia. • Aspirational peers: Average of Costa Rica, Panama, Cuba, Lebanon, Romania, Croatia, Bulgaria, Montenegro, and Mauritius. • Regional peers: Average of all countries in Latin America and the Caribbean region (excluding El Salvador). • Individual peers: Individual benchmarks for Honduras, Costa Rica, and the Dominican Republic. 153 Annexes Annex 5: Innovation and Entrepreneurship Table 13: Characteristics of businesses in the database of El Salvador % of Firms Sales Employment Fraction of women- Industry women Workers owned Number % Per firm Per worker Workers % employees per firm firms Agribusiness 1,284 6% 2,897,865 34,309 78,944 12% 61.5 15% 29% Digital Economy 982 4% 2,037,691 262,560 20,208 3% 20.6 27% 32% High-tech manufacturing 409 2% 4,337,724 45,512 29,695 4% 72.6 33% 25% Light manufacturing 428 2% 7,298,964 29,155 92,284 14% 215.6 38% 43% Other manufacturing 434 2% 2,755,797 28,359 18,838 3% 43.4 18% 28% BPO 820 4% 649,416 25,007 32,725 5% 39.9 50% 37% Finance 899 4% 3,422,830 267,221 27,246 4% 30.3 50% 36% Retail 7,863 34% 2,015,996 128,869 136,099 20% 17.3 29% 36% Tourism 1,399 6% 1,387,731 81,782 49,753 7% 35.6 36% 43% Other Services 7,043 31% 452,182 44,480 150,635 22% 21.4 35% 35% Other 1,496 6% 1,925,596 109,092 37,585 6% 25.1 10% 20% Total 23,057 100% 1,703,788 58,284 674,012 100% 29.2 31% 35% */ Yearly monetary figures in USD. Source: World Bank (2020b). 154 Annexes Table 14: Characteristics of ecosystems in El Salvador Type of Digital High-tech Light Agribusiness BPO Finance Tourism ecosystem technologies manufacturing manufacturing Fraction of businesses* None 0.60% 0.30% 0.10% 0.10% 0.20% 0.50% 1.60% Incipient 0.80% 0.30% 0.10% 0.20% 0.20% 0.20% Maturing 0.80% 0.10% 0.20% 1.00% 0.00% 0.20% 0.10% High potential 3.40% 3.60% 1.40% 0.60% 3.30% 3.10% 4.30% Total 5.60% 4.30% 1.80% 1.90% 3.60% 3.90% 6.10% Sales per plant** None 1,033,389 5,643,395 503,433 1,800,994 133,352 1,339,854 325,705 Incipient 2,048,852 528,691 264,888 8,982,474 - 581,267 187,793 Maturing 3,278,075 750,096 6,069,492 2,879,638 26,821 522,066 254,974 High potential 3,346,866 1,849,785 4,586,768 14,600,000 692,015 4,062,204 1,836,939 Total 2,897,866 2,037,691 4,337,724 7,298,964 649,416 3,422,830 1,387,731 */ Fraction of total number of businesses in the database. **/Sales per plant in USD. 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