The Americas

What's wrong with Mexico? 7-21-18

Source - Economist, Nov 10, 2018: "A misshapen economy"     

Mexico's economy is surprisingly sluggish. Real GDP per person grew at an annual rate of 1.2% a year between 1995 and 2015 - one of the slowest rates in Latin America. Economist Santiago Levy (new book is Under-rewarded Efforts - The Elusive Quest for Prosperity in Mexico) believes the slow economic growth has to do with tax policies that create perverse incentives.

From the article: "Mexico has a huge and disproportionate number of small businesses, and unusually wide variation in the productivity of its companies. The census under-counts small firms because it excludes those that lack fixed premises (such as taco stands) and those in villages of fewer than 2,500 people. Even so, more than 90% of the 4.1m firms in the 2013 census had at most five workers. And 90% of the total were “informal”, absorbing almost 33% of the capital stock and 40% of workers. Rather than “informality”, the key distinction Mr Levy makes is between firms that have salaried employees and those that do not. Four-fifths of the “informal” firms are in the second category: their staff are either self-employed or paid piece-rates or profit shares. These firms’ only legal obligation is to pay corporate tax, of just 2% of revenues if these are under 2m pesos ($105,000) a year. Firms with salaried workers, by contrast, must pay social insurance, deduct income tax and grapple with employment law (which doesn’t allow them to fire people if business drops). The census shows that firms with salaried workers are much more productive. So it is worrying that from 1998 to 2013 the weight of non-salaried firms in the economy grew. Mr Levy argues that public policies are to blame. In the name of social inclusion, in the period under study, Mexico introduced non-contributory pension and health benefits worth 1.3% of GDP, thereby helping non-salaried workers, while raising income taxes on salaried ones to the tune of 1.9% of GDP. 

The solution? Levy thinks that Mexico needs to replace restrictions on firing with unemployment insurance and shift the tax burden away from payrolls, abolish tax perks for small firms and take contract enforcement more seriously. The prize would be faster growth, better social provision and better-paid jobs.