Keys to Increase Labor Productivity in Mexico

Between 1994 and 2019, Mexico saw alarmingly little growth in productivity, especially when compared to the emerging economies that have used new technologies and digitization to catch up with first world countries, reports the World Bank. One of the country’s key issues lies in its inability to fund SMEs. 

"In Mexico there is a big problem: being a productive company does not ensure you get credit. Since funding is more concentrated in medium and large companies, this greatly limits young companies from investing and taking risks, as banks do not give them credit due to their lack of guarantees,” said Rafael Muñoz, Lead Country Economist for Mexico, the World Bank.

The Mexican economy has faced 30 years of relative stagnation and low-growth, as well as a fall in GDP per capita when compared to the US. In addition, Mexico faces a major problem in the notorious disparity between its different regions. Overall, the aggregate total-factor productivity (TFP) shows a negative value during almost the entire period between 1994 and 2019, found the World Bank after analyzing over 20 million companies surveyed through six economic censuses. 

One of the possible causes behind this problem is that Mexican companies have a strange relationship with the benefits of being productive, said Muñoz, unlike other countries with better productivity indicators. This represents a critical issue, especially considering that SMEs represent the vast majority of businesses in the country. The lack of access to financing causes stagnation in productivity. 

Mexicans are entrepreneurs, said Muñoz, as companies with less than five workers represent about 30 percent of the country's employers. But the lack of financing stops these companies from growing. "Without funding, it is particularly difficult to innovate, since the return is only possible in the medium and long term," said Muñoz. Moreover, Mexico faces many issues to obtain funding for R&D. 

“In Mexico, credit does not go to the most productive companies. Approvals depend a lot on real estate guarantees that are difficult for small companies to obtain,” said Muñoz. Furthermore, regulatory barriers, uncompetitive markets and an obsolete bankruptcy regime do not favor the exit of unproductive firms from the markets that continue to absorb critical inputs for the productive firms. For that reason, the reallocation of resources from less productive to more productive companies does not occur in Mexico, said Muñoz. 

Modern companies that are integrated into the global value chain, which are almost always foreign and multinational brands, have twice the productivity of similar non-integrated companies. However, this higher productivity is not leveraged, so other Mexican companies do not take advantage of the opportunity areas left by these major enterprises due to the lack of domestic linkages. 

Domestic companies have not been able to collaborate with these foreign companies. "Barely 25 percent of the total value of the country's exports are domestic intermediate inputs, compared to a foreign contribution of 36 percent," said Muñoz. This is a particularly low rate compared to other countries with largely manufacturing approaches such as China, he added. 

Innovation within the country is also limited by the lack of adequate business management, as there are few companies that have the necessary resources to manage the FDI that enters Mexico. This means that these resources are exclusively given to a selected group of transnational companies that have both the human and capital infrastructure to manage it. The best-managed companies in Mexico, those that are above the 90th percentile, are similar to the US-average company in level of management. 

"In general, the Mexican business community evaluates itself much more positively in terms of management capacity than it truly is. In this, Mexico is an outlier, has an average management average and has the highest self-assessment score," said Muñoz. 

Contrary to other OECD countries, the large dispersion in labor productivity among states has remained during the last three decades and most states with low labor productivity have faced stagnation. Exporting firms are geographically concentrated in the north and east of the country, which explains why these regions are better linked to FDI attraction. However, despite the lack of convergence at the state level, the analysis suggests convergence at the municipal level, so rich states are growing faster only because they have a higher proportion of municipalities growing above the national average. 

If a municipality is growing in a state with low productivity, there is no reason why the other localities in the region cannot also increase their productivity, said Muñoz. Urbanization offers higher productivity but only when complemented with the right public policies such as transportation and land use. The quality of infrastructure directly affects the productivity of the companies involved in the region, as well as the access to markets and the involvement of strong government institutions where companies feel safe to invert and grow. 

To tackle this problem, the growth of young productive companies needs to be favored, with guarantee programs for production companies that ensure financial limitations through productivity metrics, explained Muñoz. In addition, productive factors must be relocated, allowing for the mobility of labor and capital by reducing labor and business regulations that affect companies during crises. Closing regional gaps is also necessary, as well as complying with all the necessary measures within these regions.