Unlocking Mexico's Economic Potential through Innovation and Entrepreneurship

                                 Transition Policy Note



This policy note posits that Mexico’s economic growth can be driven by private
sector productivity and leveraging of impactful entrepreneurship and innovation.
Mexico's economic growth has been stagnant in recent years, with GDP per capita
increasing at an average annual rate of only 2.2 percent between 1991 and 2021 (World
Bank, 2022). Sluggish productivity growth is the main culprit, as total factor productivity
declined by an average of 0.45 percent per year over the same period (INEGI, 2022).
The COVID-19 pandemic has exacerbated these challenges, with firms facing lower
revenues, employment, and wages. However, the pandemic has also opened up new
opportunities for Mexico to attract investment and boost exports, as global companies
seek to diversify their supply chains and nearshore production to reduce risks and
improve resilience.

Mexico's policymakers can influence the quality of national and regional
ecosystems and increase the probability of generating impactful
entrepreneurship. This can be achieved by fostering the entry of more formal firms,
facilitating high growth, innovative, and globally integrated firms that can create more,
and better-quality jobs. Such firms need resources that include infrastructure, physical
capital (facilities and equipment), human capital, and knowledge, as well as access to
strong talent and markets. Regulations, and access to financial capital, as well as social
capital also affect firms' access to resources.

This note builds on the World Bank's Mexico Entrepreneurship Ecosystem Diagnostic
report and highlights critical challenges and important opportunities. Specifically, it
outlines short/medium term policy actions that the Mexican authorities could undertake
within the next two years to have on boosting firm innovation and impactful
entrepreneurship in Mexico. These high impact activities include:

1. Develop a comprehensive and coherent strategy to foster growth-oriented
entrepreneurship. At present, the spatial and sectoral distribution of entrepreneurship
is highly uneven. In Mexico, manufacturing firms tend to be more productive and
growth-oriented than those in services, and the northern and north-Pacific regions
exhibit higher levels of dynamism than the southern states (World Bank, 2022). A
comprehensive strategy should be developed via close collaboration of federal and
subnational governments and key ecosystem stakeholders such as the private sector,
research and ecosystem builders. It should also establish clear targets and mechanisms
to monitor and evaluate progress over the short, medium, and long term.

2. Expanding access to finance, especially for innovative firms and impactful
entrepreneurs. In Mexico, access to finance is limited, with only 10 percent of
microenterprises, 25 percent of SMEs, and less than 33 percent of large firms having
access to credit (INEGI, 2019) This can be alleviated by expanding access to finance
                                                                                          1
for innovative firms by:
   - Enhancing access to credit information, and tailoring a broader set of financial
instruments such as credit guarantee programs to encourage lending to younger, riskier
firms with limited collateral, and developing new types of alternative collateral such as
receivables or purchase orders.
   - Evaluating and scaling up royalty-bearing grant, seed and venture capital funds to
support high-potential startups and technology-based firms, particularly in sectors with
strong nearshoring potential.
   - Strengthening the insolvency regime to facilitate the efficient reallocation of
resources from less productive to more productive firms.

3. Investing in managerial capabilities and workforce skills. The average Mexican
firm scores significantly lower on management practices than the median US firm
(Bloom et al., 2022). About 30 percent of formal firms cite an inadequately educated
workforce as a major constraint (World Bank Enterprise Surveys). Key
recommendations to strengthen firm capabilities, include:
   - Providing incentives and training programs for firms to hire professional managers
and access consulting services to improve managerial practices and technology
adoption, especially to promote digitalization and greening of firms.
   - Collaborating with industry associations, universities, and vocational institutes to
assess and address skills gaps in high-potential sectors such as ICT, automotive, and
aerospace.
   - Strengthening the quality and market relevance of secondary and tertiary education,
with a focus on digital skills, language proficiency, and entrepreneurship training.

4. Incentivizing private sector investments in technology adoption and
innovation. Mexico spent just 0.28 percent of GDP on R&D in 2019, well below OECD
peers (OECD, 2021a). Only 12 percent of microenterprises and 10 percent of SMEs
introduced any type of innovation in 2016-2017 (INEGI, 2018). This can be remedied by
positioning firms at the center of public policy for innovation, including by:
  - Evaluating and reforming fiscal incentives such as R&D tax credits to encourage
greater private investment in innovation, and exploring alternative instruments such as
matching grants for collaborative R&D projects.
- Accelerating technology adoption, especially of digital and energy efficiency and other
environmental technologies, across all firms aspiring to grow their exports directly or via
GVCs.

- Strengthening technology transfer offices and industry-academia linkages to facilitate
the commercialization of public research and the creation of spinoff firms.
  - Leveraging public procurement to spur innovation in strategic sectors such as health,
energy, and the environment, drawing on international best practices and engaging
SMEs in the process.

5. Eliminating regulatory barriers and strengthening the rule of law. The regulatory
environment poses barriers, with weak contract enforcement and high compliance costs
equivalent to 3.4 percent of GDP at the federal level (INEGI, 2020a). Recommendations
to enhance the environment in which firms operate, include:
                                                                                          2
  - Simplifying business registration and licensing procedures at the federal and state
levels, with a focus on reducing the time and cost of starting and operating a formal
business.
  - Expanding the implementation of the Better Regulation agenda, particularly at the
subnational level, to streamline regulations and improve regulatory quality across all
levels of government.
  - Strengthening contract enforcement and alternative dispute resolution mechanisms
to reduce the costs and uncertainties of doing business, particularly for SMEs.


6. Supporting greater sophistication of Mexican exporter firms and accelerating
their integration into global value chains (GVCs). Only 4.6 percent of SMEs
participate in GVCs, and they only join around age 10 on average (INEGI, 2018).
However, nearshoring trends offer significant opportunities for Mexico to attract new
investment and boost exports in key sectors such as automotive, aerospace, and
medical devices (IADB, 2022). The promotion of interanationalization and GVC
integration can be promoted via:

   - Developing targeted supplier development programs in partnership with multinational
firms to facilitate SME linkages and upgrading in key GVC sectors such as automotive,
aerospace, and medical devices.
   - Enhancing export promotion and market intelligence services to help SMEs identify
and pursue new market opportunities, particularly in the context of nearshoring trends.
   - Improving logistics infrastructure and reducing bottlenecks in cross-border trade,
with a focus on enhancing connectivity and efficiency in the southern states.

Designing and implementing effective entrepreneurship programs will require
careful diagnostics, robust monitoring and evaluation frameworks, and close
coordination across different levels of government and ecosystem stakeholders.
The policy mix must pivot from a predominant focus on supporting subsistence
microenterprises to catalyzing high-potential growth firms, particularly in sectors and
regions with strong comparative advantages.

The costs of inaction are high. Without a strong ecosystem to enable entrepreneurs to
start and scale innovative, productive firms, Mexico risks falling further behind in the
global economy. But with the right policies and investments in place, the country has the
potential to unleash a new era of dynamic, innovation-driven growth - delivering higher
incomes and living standards for all Mexicans.




                                                                                          3
References:
Bloom, N., Iacovone, L., Pereira-Lopez, M., & Van Reenen, J. (2022). Management and
Misallocation in Mexico. National Bureau of Economic Research. Working Paper 29717.

Cirera, X., Comin, D., & Cruz, M. (2022). Bridging the Technological Divide: Technology
Adoption by Firms in Developing Countries. World Bank.

IADB (Inter-American Development Bank). (2022). Nearshoring can add annual $78 bln
in exports from Latin America and Caribbean. News Release. June 7, 2022.

INEGI. (2018). Encuesta Nacional sobre Productividad y Competitividad de las Micro,
Pequeñas y Medianas Empresas (ENAPROCE).

INEGI. (2019). Censos Económicos 2019. La Encuesta Nacional sobre Productividad y
Competitividad de las Micro, Pequeñas y Medianas Empresas.

INEGI. (2020a). Encuesta Nacional de Calidad Regulatoria e Impacto Gubernamental
en Empresas (ENCRIGE), 2020.

INEGI. (2022). Tables on Total Factor Productivity.

OECD. (2021a). Gross domestic spending on R&D (indicator).

World Bank. (2022). World Development Indicators.

World Bank Enterprise Surveys. https://www.enterprisesurveys.org]




                                                                                      4