Mexico Misallocated

Economic growth in Mexico presents a puzzle. Mexico has followed many of the standard recommendations that are said to support economic growth. For example, it has prevented a recurrence of the inflationary fevers that used to grip Mexico every few years. Rates of national investment are up. Investment in education and human capital is up. Mexican workers have a high labor force participation rate. Mexico has signed international agreements to reduce trade barriers. It has done a reasonable amount of privatization and deregulation And the result of all these changes has been slow growth. 

Santiago Levy describes this puzzle and offers his own answer in Under-Rewarded Efforts: The Elusive Quest for Prosperity in Mexico, published by the Inter-American Development Bank (July 2018). Here's Levy on Mexico's sluggish growth, which actually implies a negative rate of productivity growth in recent decades.

From 1996 to 2015, the country’s per capita GDP growth averaged only 1.2 percent per year. Moreover, this unimpressive figure arguably overestimates Mexico’s performance, as it reflects the fact that because of the country’s demographic transition, its labor force grew more rapidly than its population during these years (2.2 versus. 1.4 percent). In fact, GDP per worker grew on average by only 0.4 percent on an annual basis, far from what is required to create a prosperous country. ... 
Over the same two decades, accumulated per capita GDP growth in Mexico was 25.7 percent, less than every country in Latin America except Venezuela. ...Over the medium term, growth occurs because the labor force increases (in quantity and quality), because there is more investment in physical capital, and because the productivity of labor and capital (total factor productivity – TFP) increases. Decomposing Mexico’s growth over this period into these three components, one finds that TFP growth averaged only 0.14 percent annually, without any corrections for the quality of the labor force. Considering increases in schooling (that is, taking into account that workers with more years of schooling can potentially contribute more to output than those with fewer years), yields a negative TFP growth rate of 0.53 percent. ... [T]he result is that Mexico’s GDP growth has resulted only from the accumulation of physical capital and growth of the labor force. There have been no improvements in efficiency. Thus, by and large the question of why Mexico grows so slowly is equivalent to the question of why productivity has stagnated.

 Why has Mexico's productivity growth been so poor? Levy looks for clues in data on the productivity of Mexico's firms. In a healthy and growing economy, one expects that the average productivity of firms will rise. As part of that process, one expects that firms with higher productivity levels will tend to succeed and expand, while firms with lower productivity will either move to higher productivity, or they will contract and even sometimes go out of business. 

Levy provides data that this expected process isn't happening. In looking at data on firms in Mexico, For example, he points out that in Mexico in 2013 census data, informal firms were 90 percent of the total, "absorbed more than 40 percent of the capital stock and 55 percent of employment," and "constituted the majority in 51 percent of all six-digit sectors in manufacturing, 81 percent in commerce, and 88 percent in services." Levy writes: 

The comparison of the four censuses [from 1998 to 2013]shows that, contrary to what one would expect, the composition of economic activity shifted over time towards the informal sector, measured by the number of firms, the number of six-digit sectors where these firms are a majority, and the share of capital and labor absorbed by them. In parallel, the average size of formal firms increased, and they became more capital-intensive, but the average size of informal firms fell. The net result of all these trends was a fall in average firm size, and larger differences in capital intensity between formal and informal firms, within informal firms, and across firm sizes. In other words, heterogeneity increased across firm sizes and types. ... 
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