Dysfunctional Firm Dynamics and Mexico’s Dismal Productivity Performance

Over the last three decades, Total Factor Productivity growth in Latin America has disappointed and informality persisted. To shed light on this outcome, we exploit a unique database (by Latin American standards) for Mexico, a country where manufacturing exports grew from 7 to 33 per cent of GDP, but labor informality barely changed, firm informality increased, and TFP growth was negative. We construct a 20-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 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 informality persisted in this sector; and that despite spectacular growth of manufacturing exports, the country de-industrialized. We document that for TFP, the formal-informal composition of the economy is more important than its sector composition. While our insights are based on Mexican data, they may be relevant to countries in Latin America and other regions characterized by large informal sectors. JEL Classification Codes: O47; O54; L25; J46; D22; E26