Why Isn’t Mexico Rich? G ORDON H ANSON UC S AN D IEGO AND NBER

2 I NTRODUCTION Mexico’s ambitious record of economic reform  Mexico modernizes its banking system, 1984  Mexico lowers trade barriers and signs the GATT, 1986  Mexico privatizes 1000 state-owned enterprises,  Mexico liberalizes rules on foreign investment, 1989  Mexico signs North American Free Trade Agreement, 1994

3 I NTRODUCTION A major source of frustration for Mexico and a puzzle for international policy makers is that Mexico’s record of economic growth has been anemic If Mexico has followed the recipe for economic development, why has it not panned out? Arguments that lack empirical support  Resource curse (dependence on oil is declining)  Legacy of colonialism (shared by countries that have done well)  Drug violence (did not accelerate until recently)

Growth rate of GDP in middle income countries Average annual change log per capita GDP Country Argentina Brazil Bulgaria Chile Colombia Czech Republic Hungary Indonesia Malaysia Mexico Peru Philippines Poland Romania Thailand Turkey Venezuela

Mexico’s growth in GDP per capita, comparison (1) 5

Mexico’s growth in GDP per capita, comparison (2) 6

Mexico growth in GDP per capita, comparison (3) 7

I. Mexico’s lack of financial development The intermediation of credit from savers to investors is fundamental for the process of economic growth In Mexico, the provision of credit works poorly  Mexico’s government has expropriated assets of private banks twice in the last 40 years (1970s, 1982); banks collapsed in 1995  Despite reform of the banking system, 80 percent of Mexican households are not linked to formal financial markets  Access to capital for investment happens through large firms  Mexico’s bankruptcy laws overprotect borrowers (making lenders reluctant to make loans; auto, home loans are exceptions) 8

Credit to private sector as % of GDP Country Argentina Brazil Colombia Czech Republic Hungary Indonesia Malaysia Mexico Peru Philippines Poland Romania Thailand Turkey Venezuela

II. Mexico’s informal sector is too large In 2004, 22% of manufacturing employment was in firms with under 10 workers (and 36% with under 50 workers)  Many of these firms are informal: they don’t pay social security taxes or abide by regulations on firing or severance pay  Informal firms gain by remaining small through avoiding taxation but as a consequence of staying small have low productivity  Mexico offers health and retirement benefits to workers in informal firms, meaning formal workers subsidize informal ones  Mexico mas a “missing middle” of productive medium size enterprises that help propel innovation and growth 10

III. Many markets in Mexico are uncompetitive Telmex has a monopoly in telecommunications  Mexico has very high fees for broad band, cellular service, land lines (helping make Carlos Slim the world’s richest man) Electricity production is controlled by powerful unions  Mexico’s electricity prices are much higher than in the US  Wages for Mexico’s electrical workers far exceed those in the rest of the economy (and there is excess employment in the sector) Mexico’s schools are controlled by a powerful union  Mexico has low enrollment in post-secondary education and low scores in math and science (w.r.t. Brazil, Chile, Hungary, Korea) 11

IV. China’s impact on Mexico Mexico has the bad luck of competing directly with China in global export markets Mexico produces the goods China produces rather than the goods that China buys The consequence has been downward pressure on the international prices for Mexico’s export products 12

Share of US manufacturing imports 13

Conclusion The news isn’t all bad  Mexico now has a functioning democracy  Mexico’s innovative social policy has helped reduce poverty Yet, Mexico’s underperformance is over-determined  Weak financial system  Uncompetitive input markets, entrenched special interests  Large and unproductive informal sector  Competitive threat from China Which problem(s) to tackle first and how? 14