This article was published for the Hoover Institute. I’ve pasted a portion of the article here. You can read Full Article with citations on the Hoover Institute Website.
by Richard Aitkenhead, Benjamin Sywulka
Monday, December 3, 2018
As Digital Transformation reaches Central America, a strategic question arises: will it result in more marginalization, or in more empowerment? Writing from a practitioner’s perspective building on decades of lessons learned, the authors propose design principles for the transition. The region is systemically unprepared for the global forces that are hitting it, and the ability of the average citizen to generate income will increasingly decrease. Job creation in conjunction with business sophistication will be necessary, but it is unlikely to come from foreign direct investment, big business, technology entrepreneurs, academia, or government because of their structural realities. The most effective job-creation mechanism in Central America over the next ten years will likely be Self-Employed Platform-Enabled Entrepreneur (SEPEE) businesses. Major players in the Central American ecosystem should participate in the SEPEE economy if they want to grow, but it will require innovative incentive alignment and long-term vision.
Introduction: The Central American context and the digital transformation dilemma
Central America sits between Mexico and Colombia and is comprised of Guatemala, Belize, Honduras, El Salvador, Nicaragua, Costa Rica, and Panama. The region has a combined population of 48 Million and a GDP of $258 Billion,1 making the entire region comparable to Colombia in population and to Chile in GDP. As the region faces the uncertain future of digital transformation, it is worth noting a few key points. First, two thirds of the economy is informal.2 Second, two thirds of the population never finishes High School.3 Third, three quarters of High School graduates can’t pass a standardized math test.4 At first glance, it would appear that digital transformation is a sure recipe for further marginalization—low-skilled jobs being replaced by automation, low-educated populations being unable to add value in a digital economy and being forced to fight for survival for the few non-automatable low-skilled jobs available—decreasing average income, increasing crime, and increasing migration. The optimist may have an alternative prediction—emphasizing how connectivity, smartphones, and apps can democratize education, health, and income generation. This strategic dilemma between marginalization or empowerment should not be minimized or over-simplified. There are genuine threats to the survival of the region as we know it given how unprepared it is for the global digital economy, which operates by rules that are drastically different than the rules that have been in place in the region for the past 500 years. And yes, there are achievable opportunities to dramatically increase the quality of life of the region’s citizens—but these cannot be achieved without understanding and navigating the complexity of the Central American reality. This paper explores design principles for building the new digital Central America—from a practitioner’s perspective—taking into account decades of lessons learned from successes and failures in trying to help the region reach its potential.
Central America is systemically unprepared for the global forces that are hitting it, and the ability of the average citizen to generate income will increasingly decrease
We are beginning to see the impact of two major global forces on the Central American economy. The first is Digital Transformation—the convergence of Big Data, Artificial Intelligence, Robotics and Automation, 3D Printing, etc. The second is Conscious Capitalism—the emergence of purpose-driven companies and consumers who prioritize maximizing stakeholder value instead of focusing primarily on shareholder value.5
While for some industries being “digital,” or “green,” or “social” is more of a “nice-to-have,” in others, these forces have implied revenue, profit, or job loss. In working with executives and boards of directors in the region, we have seen anecdotal evidence of the beginnings of these trends. Agricultural industries that are candidates for automation (large, flat extensions of monoculture crops, for example) are already facing increasing financial pressure to automate their production processes, leaving hundreds of thousands of seasonal workers without a job. Artificial Intelligence has begun to take over some jobs in the Contact Center industry—where intelligent chatbots replace humans in customer service. Agricultural and manufacturing exports to the United States and Europe are facing increasing pressure to have strong environmental and social business models and/or certifications, as the buyers become more demanding and more “conscious.” Large energy, mining, manufacturing, and infrastructure projects have been shut down, delayed, or put on hold due to protests, social media pressure, and legal actions against them—shifting the power dynamics and ground rules for investing.
The combination of these forces leads to a worrisome forecast of job creation in the region over the next ten years. Foreign direct investment is not likely to grow as much as is needed because of poor investment climates—security risks, poor infrastructure, and uncertain rule of law, among others. If there are new investments, the likelihood of automation being a critical part of the investment is very high—which means that job demand for low-skilled labor will continue to be low.
While historically the region grew by supplying the world with commodities, growth in this emerging digital, conscious economy will depend significantly on the region’s ability to have more sophisticated businesses. This implies having more sophisticated infrastructure, more sophisticated production and commercialization processes, and more sophisticated talent. The challenge for the region is that closing the infrastructure, process, and education gaps is not something that can be done overnight.
There are tremendous systemic interdependencies that make the transition to the emerging digital and conscious economy extremely difficult. Let’s begin with tax collection—the region has low tax collection (14% of GDP on average),6 of which much of it goes to operating the government structures (75% of budgets), including the salaries of hundreds of thousands of government employees (38% of budgets).7 This leaves little room for investment in infrastructure—and the little that is invested often is of poor quality given the corrupt schemes by which the contracts are awarded. The lack of road, port, and airport infrastructure in turn increases operating costs for businesses, but also for the health and education systems. With tight operating budgets, basic health and education services are poor both in quality and coverage. The combination of needing to contribute to the family’s income generation activities (almost one fifth of the workforce is 7 to 14 year-olds),,8 poor road and school infrastructure, learning difficulties due to chronic malnutrition, and limited access to high-quality teachers results in a region where one third of the population never finishes primary school,9 and two thirds never finish secondary school. Of the one third that does finish secondary school, less than a quarter can pass standardized math tests, and less than 11% go on to pursue a University degree (only 6% in the northern countries of the region).10 This leaves most people with no choice but to work in low-skilled jobs, which in the northern Central American economies that are 73% informal11 entails earning between 35% and 90% of minimum wage,12And to close the vicious cycle, none of those informal businesses pays taxes, which brings us back to the low tax collection with which we started.
As the digital and conscious economy demands more sophisticated businesses, there will be a huge shortage of talent with the minimum competencies necessary to be employable, and a huge shortage of job openings for low-skilled labor.
Job creation in conjunction with business sophistication will be necessary, but it is unlikely to come from FDI, big business, tech entrepreneurs, academia, or government.
The authors of this paper have been leading and facilitating investments and strategic efforts in the region for several decades, and in the last decade, have played key roles in Digital Transformation efforts in large businesses, government, academia, organized private sector, and civil society. What follows is a practitioner’s perspective on strategic approaches for the region over the next ten years, based on anecdotal learnings of enablers and barriers that have been identified working intimately with many stakeholders on these exact issues.
Foreign Direct Investment: The investment climate is poor
One the main mechanisms used historically for creating jobs is Foreign Direct investment. FDI in the region is $12 Billion (5% of GDP).13 FDI can be a good mechanism for creating jobs in the digital economy, as foreign investors introduce new technologies into the ecosystem, and over time the capabilities and skillsets remain inside the regional economy. FDI growth, however, requires several critical elements: rule of law, infrastructure, available talent, and ideally tax incentives. From an investment climate point of view, the region’s average score is 59 points (4.1 out of 7).14 with the most common barriers to competitiveness being corruption, inefficient government and bureaucracy, inadequate infrastructure, crime and theft, tax rates, and inadequately educated workforce. Attracting call-center investments, for example, has been a big priority for the region, and has had a very positive impact. But expanding the investments beyond their current capacity will require major efforts in improving infrastructure, revising wage laws and tax laws, and increasing the talent pool with English and technical skills. These changes require major government commitment, and it has been difficult to move forward on many initiatives that could catalyze more FDI. With the exception of Panama and Costa Rica, Central American governments have had a hard time aligning their stakeholders around significant FDI efforts. In addition to this, political polarization—bringing back deep-seeded fears on both sides of the ideological spectrum—has risen to destabilizing rates in Guatemala, Honduras, El Salvador, and Nicaragua—and the polarization is likely to continue for the next 3-5 years—which significantly detracts long-term investments and fosters capital flight and migration. In this context, FDI is unlikely to be the main mechanism of job creation in the digital economy.
Medium and Large Businesses: The family-owned businesses are risk averse
A second source of job creation would be growth of the medium and large businesses. From a corporate strategy perspective, these businesses can grow inorganically and organically. Inorganic growth through M&As is likely to continue as larger players consolidate in the region. But this type of growth doesn’t necessarily lead to job creation, as the consolidation process often focuses on optimizing workforces—although the good news is that these mergers do tend to increase best practices and technology adoption. Organic growth can come from top-line and bottom-line growth. From a Digital Transformation perspective, companies can and should incorporate “digital” into their growth strategies in two major ways. The first is to digitize their current business—this implies incorporating digital technologies, mindsets, and processes that increase efficiencies (bottom-line impact) and go-to-market abilities (top-line impact). The second is to build new digitally-enabled business models—where entirely new value chains are created that eventually become the new rules of the game for the industry.
Before making predictions on the ability of medium and large businesses to sophisticate their businesses and create new jobs in the digital economy, it is important to understand the underlying structural realities of Central American businesses. The vast majority of the Central American businesses are family-owned (the Latin American average is 85%;15 Central America’s is probably higher). This has two major implications—the first is that the financial return model tends to be dividend-driven, not capital-gain driven. Medium and large businesses aren’t usually looking for exits; they are looking for steady dividends to maintain the living standards of shareholders. The second is that as the companies are privately owned, there is no secondary market for shares, and therefore no pressure to have robust innovation pipelines that could drive up share prices. The impact of these structural realities is that investment decisions tend to gravitate towards lower-risk, shorter-term return opportunities.
Bringing this home to investments in digital transformation—companies tend to wait until technologies have been de-risked, best-practices have been developed, and business cases with near-term returns can be easily made. This works well for many “digitizing the current business” initiatives, because early adopters in other geographies have proven that the technologies add value and the investments fit the “copy/paste” strategic profile of the companies. In terms of job creation, this implies that many low-skilled jobs will be replaced by technologies in the coming decade, and a whole new pool of jobs will be created in skillsets where there is virtually no supply—data scientists, innovation managers, robotics engineers, etc. The profile does not work so well for “building new digital business models” initiatives, because these entail a much higher risk, much more experimentation to find product/market fit, and much more energy to educate a non-digital market before adoption even becomes an option. While there are some exceptions, particularly among telecom companies, management structures and incentives are rarely aligned with developing these types of business models—and therefore the task of building these new digital businesses falls on the shoulders of technology entrepreneurs.
Technology Entrepreneurs: Their ecosystem is weak
The challenge with these entrepreneurs is that they tend to operate in a systemic vacuum—where they don’t have financing mechanisms like angel and venture capital, accelerators, and most importantly, a strong B2B network of partners and customers to support them and buy from them. As much as B2C technologies with millions of users appear to be icons of the digital age, it is the more boring B2B technologies that have actually fueled tremendous growth in digital ecosystems. Central American technology startups often face the challenge that there is no market for their innovations within Central America, because those who should be buying from them are late adopters, not early adopters. It has been easier for many entrepreneurs to find the support they need—both on the customer side and the investment side—outside of the region. There are of course exceptions, but as a rule, corporations prefer to buy proven technologies, and family offices (the principal source of investments for these kinds of businesses) prefer to invest in proven businesses that have already been de-risked—an ecosystem that is difficult to survive in as a tech entrepreneur. As a result, many tech entrepreneurs de-risk their own income generation by taking on full-time jobs at companies, and their emerging technologies never take off. Emerging technologies remain more akin to academic endeavors and “nice to have” projects, instead of strategic assets tied to business growth.
Academia: It’s difficult for them to align to industry needs
Another key player in job creation is Academia, not so much because it creates employment, but because it creates employability. Universities try, of course, to link themselves more effectively to business growth strategies. They are acutely aware of changing industry needs, and that they must adapt to the demands of the future job markets. They face, however, two major challenges. The first is that student demand is often not aligned with employer demand. In most cases, students must decide what they will study before enrolling in the University. Their perception of what a good career would be is often not aligned with the reality at the other end of the five-year journey. In addition, parents play a huge role in the decision of what to study—and since student loans are given on the basis of the parents’ collateral—not on the basis of future incomes of the graduate, their opinions weigh heavily. The second challenge is that Universities have a very difficult time interacting with the private sector. Although some have made strides in setting up open innovation programs or trainee programs, there is very little collaboration between corporations and universities—whether for research and development, work-study programs, or simply calibrating degree offerings or degree requirements to industry needs. Universities are structurally designed to prioritize student needs and higher education regulations over industry needs—which creates a big gap between University outputs (both talent and research) and business requirements. This problem will escalate as businesses are forced to transition to the digital economy, and Universities will have a hard time restructuring their own business models to respond more effectively.
Government: Not Nimble and long-term enough
Governments around the world have been effective at creating jobs—even jobs in the digital economy—by a combination of tax incentives, subsidies, tailored regulations, trade agreements, credit offerings, infrastructure commitments, and capability building programs. Most of the Central American countries have used some of these mechanisms to attract investment. There are several challenges moving forward for the region’s governments, however. One of them is the deep level of polarization in the region—which makes it very difficult to get enough alignment among stakeholders to create laws and implement programs that will actually create jobs in the digital economy. Even something as basic as trying to improve educational outcomes in public schools can be a tortuous journey that can cost public servants their job and their future (it’s not uncommon for Ministers to leave their post with dozens of lawsuits against them—including a few penal ones—that they have to deal with for the next 10 to 20 years). One big opportunity for creating jobs in the medium-term that is Government-driven is increasing transportation and housing infrastructure. The region has an average of 2 meters of roads per inhabitant,16 for example, and needs to move to 3–5 meters per inhabitant in the next decade (the United States has 20 meters of roads per inhabitant).17 The reasons for the low buildout are many, but part of the problem is the dozens of laws and regulations (many contradict each other) that need to be complied with in order to build out new infrastructure. If Governments manage to align their stakeholders, they can rewrite the rules for infrastructure development in order to accelerate investment and job creation, but this is very difficult to do in the context of political polarization.
A second challenge is that even if laws are passed, public policies are signed into effect, and agreements are reached, governments rarely have the resources to build the needed sustainable ecosystems around those initiatives for them to have the desired impact. A country might be able to establish a Special Economic Zone, for example, but in order for that zone to work, a huge amount of energy, money, and coordination is required to supply the infrastructure, water, energy, telecom services, roads, ports, logistics services, public transport systems, raw materials and supply chain suppliers, general and administrative services suppliers, and of course the qualified talent to work in the companies that will be operating in the Special Economic Zone. Having qualified talent is in and of itself its own huge project that requires investing not only in massive training, reskilling, and formal education efforts, but also in housing, education, health, recreation, and transport infrastructure for the families of that talent. Building minimum viable ecosystems is tremendously difficult, and requires a lot of patience, trial and error, innovation and pivoting, and willingness to persevere beyond the originally planned budgets and timelines.
The digital transformation of the region will require a counter-intuitive mixture of long-term strategic commitments that can withstand multiple electoral cycles, and short-term tactical flexibility that allows for experimentation, pivoting and nimble execution. Central American governments typically do not have institutions that can operate under those design principles—making it difficult for them to spearhead the transformation process. They will likely talk as if they are the protagonists of the show, but in reality, do little more than give some opening words. The real work will be up to the shapers of the digital ecosystems.
The most effective job-creation mechanism in Central America over the next ten years will likely be Self-Employed Platform-Enabled Entrepreneur (SEPEE) businesses.
We have seen organizations make two major mistakes when it comes to digital transformation. The first is the assumption that digital transformation is about technology transformation—in reality it is more about people and culture transformation. The second mistake is the assumption that it’s primarily about implementing new technologies, when in reality it’s primarily about solving problems—particularly deep human needs that haven’t been met yet. This is relevant to our discussion, because if we look at the challenge in the region from the perspective of gaps that need to be closed, it can be overwhelming. If we look at it from the perspective of unmet human needs that can be solved more effectively, digital transformation brings hope.
While some analyses focus on the outliers—how the best of the best of the region do amazing things despite their contexts, or how the most disenfranchised have become even more disenfranchised as the world changes—this analysis prefers to focus on the average rather than the outliers—how can the digital transformation strategy of the region create a better quality of life for the average citizen?
Using this as a starting point for the strategy, the greatest unmet need of average citizens in the region is income generation. While national strategies in the region have focused on solving income generation through formal job creation, digital transformation opens up the door to solve income generation itself. As it is, in a context where two thirds of the businesses are informal, and 80% of new businesses never grow beyond 5 employees,18 self-employment is already a widespread reality. What has become popular in developed economies—the “gig economy”—has been a reality for a long time in the region—in fact, it has been the only source of income for much of the population. The difference is that gig economy platforms today are open meritocracies in which people can expand their client base and pricing through rankings and reviews. The non-platform-enabled gig-economies of Central America are closed “arbitaucracies,” where people have to succumb to pricing and market access restrictions imposed by brokers who arbitrage between supply and demand. These brokers connect marginalized people with buyers for their products and services, but their business models tend to be low-volume high-transaction-cost models, in contrast to digitally-enabled platforms that tend to use high-volume low-transaction-cost business models. The “offline” marketplaces for products and services in the region tend to be very inefficient, friends and family-based, geographically limited, non-transparent, and unfairly priced due to significant arbitrage. The online marketplaces are introducing transparency, trust, and efficiency into the transaction culture, and platforms like Uber and AirBnb are already generating income for thousands of people in the region.
There is a tremendous opportunity to empower the average Central American citizen to generate income through better platforms and marketplaces—but it is far more complex than “build it and they will come.” There have been several utopian attempts to empower the disadvantaged through information tools, but the reality is that it takes a whole lot more than information to make the marketplaces more efficient. Efficient marketplaces tend have a lot of hidden scaffolding around them that make them work—some examples include Uber car lessors who make it possible for people without a car to become Uber drivers, digital marketing strategists that increase the likelihood of Amazon products being found by buyers, cleaning companies that take care of AirBnb rentals, training communities and tutorials for TaskRabbit taskers to learn new skills that allow them to earn better rates, and insurance policies for Turo (peer-to-peer car rental service) drivers. This scaffolding is exactly what is missing when trying to implement in Central America the digital platforms that have worked in other geographies.
Our experience has been that in addition to providing the platforms themselves, investments need to be made in the scaffolding as well. Starting a self-employed business in the informal economy can be painful, but the biggest barrier tends to be obtaining the credit to get started, the know-how of the business, and the suppliers. Moving from empirical business practices to digitally-enabled platform economies requires a whole new set of abilities and processes—from setting up bank accounts, receiving trainings and certifications, obtaining credit, acquiring licenses, registering legally for invoicing, and hiring an accountant to file taxes. Our experience is that without support in the “onboarding,” it is very difficult for the average citizen to enroll and participate in these platforms. Yet, now, more than ever, there is a tremendous opportunity to shape these business ecosystems digitally in a way that creates income generation opportunities at scale for average citizens.
It is also important to note that platforms are not just digital marketplaces—there are several non-digital self-employment platforms that have worked very well in the region. These include catalog sales companies (mostly women selling to other women—cosmetics, clothes, and homegoods), productive linkage programs (supply chain incubation—used mostly in agriculture and handicraft exports), and micro-franchises (usually small retail shops—pharmacies, fast-food, mini-stores, etc.). These self-employment enabling platforms are generating income for hundreds of thousands of people in the region and still have a lot of room to grow. They are also ripe for digitalization—as onboarding, transaction, payment, and operating costs can be reduced significantly with emerging technologies.
Our hypothesis is that the best way to leverage digital transformation to increase wellbeing in Central America is by creating more Self-employed Platform-Enabled Entrepreneurs (SEPEEs). This requires investments in incubating proven business models, packaging them as a “business-in-a-box,” developing robust and efficient onboarding processes so that average citizens can implement or enroll in de-risked self-employment businesses (this includes offering micro-credit and micro-leasing schemes), and offering robust technology platforms that enable operating the businesses efficiently (including supply chain, procurement, commercialization and financial administration). The SEPEE model could be applied to hundreds of unmet needs in the region—bakeries, day-care centers, mini-stores, electrician services, plumber services, concrete floor pourers, clean water services, trash collection and recycling services, and the list goes on. At a scale of hundreds of thousands, there a lot of use cases and business cases for emerging technologies, and digital transformation becomes a much-needed enabler.