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Productivity is key to Mexico's future growth

This isn’t the first time that Mexico seems to be turning a corner and growth is on the horizon – and a recent report questioned whether this truly is Mexico’s moment or if the country will disappoint again.

The answer lies mainly in the country’s ability to increase productivity, said Jaana Remes, a partner at McKinsey Global Institute at McKinsey & Company.

Remes discussed the findings of the firm’s report,“A Tale of Two Mexicos: Growth and Prosperity in a Two-Speed Economy” at an event Wednesday hosted by UC San Diego’s Center for U.S. – Mexican Studies at the School of International Relations and Pacific Studies.

The report found that low productivity has kept Mexico from growing, Remes said. The Bank of Mexico estimates the country’s GDP growth at 3.5 percent for 2014, but Remes said it’s headed for closer to 2 percent unless productivity growth triples from its 0.8 percent per year average.

“Even today, when you look at the real value added, Mexican workers today are not more productive than they were 30 years ago,” Remes said, adding that it’s a “tragedy of the nation.”

Mexico has experienced less than 30 percent of all GDP growth from productivity, she said. The growth challenge for Mexico is to expand not only because more people are working, but also are more productive workers.

She discussed the differences between large, modern corporations with 500 or more employees per establishment; small, traditional companies with less than 10 employees per establishment; and mid tier companies.

The large, modern corporations had a productivity level in 1999 slightly more than three times the productivity of the smallest companies. By 2009, the large establishments had increased their productivity by 5.8 percent per year, while productivity at the smaller companies plummeted by 6.5 percent – bringing their productivity to one-tenth of the productivity of the larger establishments, Remes said.

Productivity at the mid tier companies was basically flat over the 10 years.

For the next 20 years to look different from the past 20, Remes said Mexico needs to see three key levers: Traditional enterprises need to evolve into modern, formal small and medium-sized enterprises (SMEs); access to capital needs to be expanded; and Mexico needs to continue to be a place where world-class companies prosper.

She looked at what is keeping the small companies from growing, and found the cost of social security for formal workers and labor laws that restrict layoffs, which are avoided by informal hiring.

Informal companies are those that don’t comply with all regulatory requirements and may not be registered with the authorities, according to the report.

The costs associated with starting a formal business in Mexico – about 10 percent of the average income – is seven times higher than it is in the United States, Remes said. Commercial customers in Mexico also pay 73 percent more for electricity than commercial users in the United States, according to the report.

“For all of these reasons, many businesses want to stay small and informal. … The incentives to grow are lower,” Remes said. “If they want to grow, they want to find a way to reduce being caught by all of these costs.”

A bakery with three or four successful operations told Remes that it chooses to have fragmented businesses instead of a bigger business with economies of scale. Remes said this is not that unusual in Mexico.

“The red tape in Mexico, even after NAFTA, is still a significant barrier for many small businesses,” Remes said.

Those companies that do wish to grow have trouble because of the lack of access to capital. NAFTA (North American Free Trade Agreement) has worked well for large corporations, Remes said.

“Large corporations’ access to global capital has dramatically changed. It has really worked for them. That has not happened for the rest of the economy,” Remes said.

The price paid for loans is significantly higher in Mexico than in the United States. SME loans have interest rates at 20 to 25 percent, compared to 3 to 4 percent in the United States. Consumer credit has rates of 25 percent-plus – compared to about 8 percent in the U.S. – and microcredit has 70 percent interest rates, compared to 8 to 15 percent in the United States, according to the report.

Mexico’s financial stock at 130 percent of its GDP is “very low” relative to other emerging markets, Remes said. Its lending will continue to be a constraint at about 33 percent of its GDP, which is right behind Ethiopia.

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