/KEIT_WBFastBrief71

October 2010 · Number 71

Knowledge and Innovation for Growth and Job Creation in Tunisia Ndiame Diop1 Introduction: For Middle Income Countries, the global crisis has not overshadowed the longer-term, structural, deep-seated challenge of growth and job creation. In this vein, Tunisia is gradually moving to a knowledge-based economy to effectively capture knowledge externalities from global integration and better use its strong human capital base to boost productivity and growth and employ a growing number of university graduates. The goal is growth above the 5 percent norm and lower high unemployment.

Knowledge has played a crucial role in development from time immemorial but the rapidity with which knowledge is reshaping the global economy is unprecedented. The speed in the creation and dissemination of knowledge has dramatically increased the rate at which products and services are created and traded. Conjointly, the risk of falling behind is heightened for those unable to keep up. Yet, fostering a knowledge economy is a complex, long-term task. This note summarizes the conceptual links between knowledge, growth and employment, discusses the rationale for Tunisia‟s move to a knowledge-based economy, and the key reforms needed for this.

Conceptual Considerations on Knowledge, Growth and Employment: In the new growth models, investment in knowledge helps generate new ideas and processes which allow production of new products, services, and new production processes. Since Schumpeter‟s pioneering work, this has been called innovation2. Innovation is costly, but it 1

Lead Economist, MNSED. This Fast brief was cleared by MNSED Director Ritva Reinikka.

2 Schumpeter defines innovation as consisting of (i) new products and services; (ii) new processes; (iii) new ways to penetrate new

produces economic rewards that can be patented or copyrighted.3 These marketable ideas entail positive externalities which are captured by individuals, and firms. Thus, when entrepreneurs innovate, countries can grow in spite of diminishing returns to capital and labor. In today‟s global market, innovation is key to increasing market share. Around 60 percent of export growth takes place through new product varieties, rather than higher volumes of the same goods4. The key, then, is how to bring about innovation.

As endogenous growth models note, education and human capital are a precondition for absorbing ideas and innovation. It is critical though to complement education policies with trade, business environment and other reforms to ensure effective use of educated individuals.

For example, trade of goods and services, foreign direct investment (FDI), technology purchases and licensing are key to tapping into global knowledge.

FDI and Innovation: FDI often comes with know-how and new products, processes and ways of doing business. Yet, higher FDI inflows do not necessarily mean higher value added and productivity. FDI generates spillover effects when allocated to higher value added sectors, generates demand for R&D, in-country entrepreneurship is developed and crosssectoral links are strong.

The role of In addition institutions competition

Free Entry and Fair Competition: to trade openness, policies and promoting free entry and fair tend to pressure entrepreneurs to

markets; (iv) new supply sources or distribution methods, and (v) new industries (Schumpeter 1912/1961, p.66).

3 This is because new ideas can be used to generate other new ideas that can lead to innovation.

4 See empirical analyses such as Hummels and Klenow (2005).

invest and innovate to remain competitive. This strand of the literature is straightforward (i) removing barriers to entry and competition is crucial to promoting innovation; (ii) protection of property rights provides an enabling environment, increasing incentives for innovation; (iii) facilitating investment in innovation by promising catch-up firms is also important and; (iv) improving firms‟ access to finance and putting in place industrial upgrading programs5 are all tools that can help.

What do we learn from the literature on knowledge, innovation and growth? To summarize: (i) Application of knowledge is now recognized as a key source of growth; (ii) Innovation is using knowledge to produce new marketable approaches, products and services innovation is not just creating new technologies, and more than R&D. Openness to regional and global trade and FDI is crucial to innovation; (iii) The quantity and quality of human resources is critical: (iv) The business environment and competition strongly impact on firms‟ willingness and ability to innovate; and (iv) The state has a key role – setting the enabling environment for the above, an effective support system with educational and R&D institutions, infrastructure, especially ICT, and effective policies for marketable knowledge gathering and dissemination.

Rationale for Tunisia’s move to a knowledgebased economy: In addition to its macroeconomic stability, there are at least four major reasons why moving towards a knowledge-based economy is a sensible development strategy for Tunisia. These are (i) the country‟s trade openness; (ii) the availability of human capital; (iii) the need to enhance competitiveness (iv) the specific nature of Tunisia‟s unemployment problem – studies show a strong positive relationship between knowledge-intensive means of production and demand for highly skilled workers and hence a way of dealing with Tunisia‟s large number unemployed university graduates.

Trade and FDI openness: Tunisia‟s economy is open to FDI since the early 1970s, when the

government established an attractive offshore regime with the aim of boosting exports and reducing the anti-export bias in its then protectionist policy stance. In 2008, FDI represented 6 percent of GDP. Since the mid1990s, the country has accelerated its openness to trade and today, goods trade with the EU, the Greater Arab League partners and a large number of bilateral partners is duty-free.

Because more than 90 percent of Tunisia‟s trade occurs with these preferential partners, the average applied tariff is low (4 percent) and exports (in value) represent half of the GDP.6 There is strong evidence that trade integration has been a key driver of technical progress and structural transformation in Tunisia.

Through easier access to technology-intensive equipment and machinery, greater penetration of new markets and enhanced competitive pressure, trade integration has led to a gradual structural transformation of Tunisia‟s production and export as evidence by the growing share of medium tech exports in total manufacturing exports.

In turn, the change in the production structure is also consistent with the upward trend in productivity. The contribution of total factor productivity has increased constantly since the mid-1990s. Total factor productivity now accounts for 45 percent of GDP growth against 35 percent in 1995. Yet, the scope for further increasing productivity through trade integration is large. Tunisia‟s labor productivity in manufacturing sectors exposed to international competition is at 73 percent of the EU‟s. In contrast, average productivity is 33 percent of the EU‟s in the least globally exposed manufacturing sectors. In the not-so-open services sector, labor productivity is about 45 percent of the EU‟s (World Bank 2008a).

Human capital and growth Models: Tunisia has an educated workforce - education absorbs 7 percent of GDP, produces university graduates in massive numbers yet needs to enhance quality of education and move larger numbers to science and engineering. Tunisia's past growth model of cheap labor and See the “Tunisia Global Integration Study”, World Bank (2008a).

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Such as the Mise a Niveau program in Tunisia

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competitiveness in low value-added sectors is no longer tenable. The bulk of its exports go to competitive and mature markets (Europe) where downward pressure on prices is strong.

As the Asian tigers7 left light manufacturing, China entered and its manufacturing efficiency and scale has pushed down prices. This is a key challenge for countries that are in global manufacturing and have developed a middle class. No country can remain competitive in labor-intensive industries indefinitely, especially those like Tunisia with limited labor and natural resources where surplus labor is quickly absorbed and wages rise with the development of a middle class.

Knowledge-based economy: a solution to Tunisia’s unemployment problem: Tunisia struggles with high and persistent unemployment, especially among young university graduates who have unemployment rates of 20 percent, and 27 percent for those aged 20-29 years, i.e. the higher the level of unemployment. The national average is 14 percent.

Reducing unemployment remains a top priority with 900,000 new jobs will needed in the next 10 years to avoid further deterioration. 8 Mismatch between the economy and the education sector: Tunisia‟s unemployment phenomenon is not frictional (unemployment rate have been high since the mid 1990s), not Keynesian (internal and external demand have been dynamic and supported GDP growth over the last 15 years) and not classical (international benchmarking has Tunisia competitive in wages with rising labor productivity). Indeed, while the education system generates a large number of higher-education graduates, the economy is dominated by sectors employing mostly low-skilled workers9. In 2007, the country produced 60,000 university graduates; 60 percent of new entrants to the labor market had university degrees, however, only a

fraction of the 70,000 new jobs created were in skill-intensive sectors.

Tunisia needs to move up the value chain and the technological ladder and promote new investments in skill-intensive sectors to increase value addition, boost productivity and reduce unemployment. Intense utilization of lowskilled labor and low value addition rates are the main characteristics of current production functions, especially in exporting sectors, dominated by manufacturing and tourism.

Growth in these sectors means greater demand for low-skilled labor. In the current structure, elasticity of overall employment to growth is bound to be low and high growth rates do not reduce unemployment significantly.

Key reforms to advance the knowledge economy: Building on the previous 11th plan10, the 12th development plan (2011-2014), goes further in articulating a more precise knowledge and innovation-driven growth path: (i) continue trade and business environment reforms.; (ii) enhance the quality of education and skills and; (iii) improve the efficiency of the innovation system, including public mechanisms to finance innovation.

Further trade and business environment reforms: Tunisia‟s integration process is an unfinished business. Today, the remaining reform agenda revolves around opening services sectors further to investment and competition, reducing non-tariff barriers (NTBs) including through mutual recognition of regulations and standards and promoting regional integration initiatives especially in the area of air and maritime transport.11 Services in Tunisia contribute 60 percent of GDP, higher than the MIC average of 53 percent but less than the OECD (70 percent).

Tunisia has the basic endowment (human capital, proximity to the EU, etc.) that can make it a serious contender in ICT-enabled services, legal and accounting services, health tourism,

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Korea, Taiwan-China, Hong-Kong-China, and Singapore The World Bank has significantly contributed to diagnosing unemployment in Tunisia through analytical work including an Employment Strategy Report ( 2004) and two Miles Reports 2007 and 2008).

9 Textiles and clothing, agro-industry, electrical and electronic components assembly, agriculture, and tourism.

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The 11th development plan (2007-2011), articulated a strategy for a knowledge-based economy, i.e. (i) refoms to gain investment in high value-added sectors; (ii) improve quality of education and human resources; (iii) diffusion of ICT and (iv) enhance the innovation system.

11 See World Bank 2010 for an elaboration.

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etc. This means a strong emphasis on reforming backbone services given the crucial link between the quality and cost of backbone services (telecom, transport, services and finances) and the ability to export services and goods competitively in the global market.

According to the World Bank many backbone services - engineering, mobile telephony, transport, are fairly open - restrictions remain in fixed telephony, distribution, air transport and others. Reforms would include: (i) Telecom, entry of a new fixed operator will boost competition, increase private investment, reduce prices, facilitate modern data transmission, etc (ii) Air transport, a bilateral „open skies‟ agreement with the EU would bring low-cost carriers with competitive pressure on air fares, next would be a similar agreement with regional partners; (iii) Professional services (legal, auditing, accounting, etc.), Tunisia should seek bilateral concessions in its EU Association Agreement to ease outsourcing of back-office services; (iv) Distribution (wholesale and retail), barriers remain for foreigners, easing restrictions would mean large gains.

With low tariffs, NTBs are now the major hindrance. NTBs are lower than Morocco and Egypt, but higher than Jordan, Turkey, Romania, Bulgaria and EAP and LAC MICs. Tunisia should reduce NTBs and lead in reducing these in the Union of Arab Maghreb and the Arab League.12 There are also targeted areas like promoting maritime transport links in particular between Tunisia-Morocco, Tunisia-Algeria, Tunisia-SSA countries would greatly assist regional integration. Global experience shows that establishing these transport links would expand trade and penetrating new markets in SSA, etc. will boost innovation as firms face new markets.

Education: Besides improving quality, Tunisia needs to guide students towards sciences and engineering. A recent survey found that over 60 percent of Tunisian firms struggle to find financial specialists, communication specialists, specialized IT skills, etc. To improve quality at the tertiary level, it is also important to improve quality upstream and enhance selectivity at entry. Universities and engineering schools 12

The World Bank has launched a program in partnership with PAFTA to support reform of NTBs in the region.

need more autonomy and reforms towards this end and to adopt the Licence-Master-Doctorat a la the US have been launched. A new law allows university financing by contracting for research or fees and combines learning in universities with vocational training centers and enterprises while increasing IT, English and entrepreneurship learning.

Labor Markets: Flexibility in labor markets enhances mobility across sectors and firms and reduces job informality. Labor regulations give employers full flexibility in hiring and firing for up to 4 years, lengthy exit procedures then kick in. This is a hindrance to labor mobility.

Surveys show rigid firing laws bypassed as firms offer short-term, informal jobs. Relaxing firing laws would ease formal job creation and firm restructurings, enabling greater innovation and productivity. The public placement agency (ANETI) is being reformed, to enhance information on jobs and services while new regulations formalizing private intermediation are in the works.

Strengthening Tunisia’s innovation system: Over 95 percent of Tunisian firms are SMEs with little capacity to innovate and needing a strong innovation system. Tunisia spent roughly 1.25 percent of GDP on R&D in 2009, researchers per million people are above the regional average, and it has a complex innovation infrastructure with numerous public programs.

Yet results are modest. In 2008, there were 26 international patents - below the regional average. Critical reforms innovation system include (i) rebalancing the innovation strategy, with more emphasis on technology adoption and adaptation versus technology creation, (ii) enhancing efficiency and effectiveness of R&D spending and (iii) strengthening the financing of innovation.

Contact MNA K&L: Director, MNACS: Emmanuel Mbi Manager, MNADE: David Steel Regional Knowledge and Learning Team: Omer Karasapan, Aliya Jalloh, Hafed Al-Ghwell, and Roby Fields Tel #: (202) 473 8177 MNA K&L Fast Briefs: http://mnafastbriefs The MNA Fast Briefs are intended to summarize lessons learned from MNA and other Bank Knowledge and Learning activities. The briefs do not necessarily reflect the views of the World Bank, its board or its member countries.

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