The Two Mexicos

MEXICO CITY – Mexico is making headlines of late. For a change, they are mostly positive. January marked the 20th anniversary of the North American Free Trade Agreement, the treaty that created a single market with the United States and Canada, and helped to propel Mexico into the top ranks of manufacturing exporters. The reform agenda of President Enrique Peña Nieto has received global attention. And, in recent months, global leaders in auto and food manufacturing have announced multi-billion-dollar investments in new facilities.

Indeed, in a world that has grown nervous about emerging economies, Mexico stands out as an island of opportunity, with a stable fiscal position and the prospect of rising demand for its goods as the US recovery gathers momentum. Yet there is another side to the Mexico story. For all of its successes under NAFTA and other market-opening devices, the country has recorded relatively slow GDP growth. For the past 20 years, annual GDP growth in Mexico has averaged about 2.7%, which is low by emerging-economy standards and not enough to raise living standards substantially across a growing population.

The main factor behind Mexico’s anemic growth is chronically weak productivity increases. If Mexico cannot find ways to spur higher productivity soon, it could be headed to 2% growth, rather than the 3.5% that is widely expected. That is because population aging and a falling birth rate will slow the flow of new workers into the labor force, the source of more than two-thirds of GDP growth in recent decades.

The solution to the productivity problem is easy to state but difficult to accomplish: the country must bridge the widening gap between the “two Mexicos” – the agile, dynamic, post-NAFTA modern economy (the “Aztec tiger”)and the traditional economy of slow-growing, unproductive traditional businesses. These two Mexicos are pulling in opposite directions, which explains why three decades of reforms to open markets, privatize industries, embrace free trade, and welcome foreign investment have failed to raise growth rates. This is the central finding of our recent research.