Dysfunctional Firm Dynamics and Mexico's Dismal Productivity Performance

Total Factor Productivity fell in Mexico since the early 1990s despite many reforms to increase efficiency, including multiple free trade agreements, privatization of state-owned enterprises, and the creation of regulatory agencies to promote domestic competition. We exploit a rich firm database to understand this outcome. We construct a twenty-year panel and analyze firm dynamics from two perspectives, the formal-informal and the sector composition of the economy.

In the first case we show that firm dynamics were dysfunctional: high productivity formal firms exited; surviving firms hardly grew, and their productivity fell because more informalized than formalized; and entrants were less productive than survivors, mostly because of large informal entry.

In the second case we show that while manufacturing performed relatively better than services and commerce, its contribution to TFP was modest because, despite a remarkable increase in manufacturing exports, its share of resources and GDP fell, and informality in the sector persisted. We document that for TFP, the formal-informal composition of the economy is more important than its sector composition.

Back-of-the-envelope calculations show that absent the institutions that give rise to informality, Mexico would have experienced positive TFP growth.