This paper explores the role for specific structural distortions in explaining Mexico’s weak productivity growth through the resource misallocation channel. The paper makes two contributions. First, we validate the approach of measuring misallocation indirectly (Hsieh and Klenow, 2009) by illustrating a close correlation between misallocation and per capita incomes across Mexican states. Second, we exploit the large variation in resource misallocation within industries and across states together with unusually rich data at the firm, local, and industry level to shed light on its determinants. We identify several well-defined distortions that have a statistically and economically meaningful effect on productivity via resource misallocation.

Why has an economy that has done so many things right failed to grow fast? Under-Rewarded Efforts traces Mexico’s disappointing growth to flawed microeconomic policies that have suppressed productivity growth and nullified the expected benefits of the country’s reform efforts. Fast growth will not occur doing more of the same or focusing on issues that may be key bottlenecks to productivity growth elsewhere, but not in Mexico. It will only result from inclusive institutions that effectively protect workers against risks, redistribute towards those in need, and simultaneously align entrepreneurs’ and workers’ incentives to raise productivity.

This Selected Issues paper assesses the economic impact of Mexico’s structural reforms. The Mexican authorities have been implementing an ambitious structural reform agenda in a coordinated effort to lift productivity growth. The reforms have targeted a broad range of industries; dissolved state monopolies; and addressed labor market, education, and governance shortcomings. The analysis suggests that external headwinds have masked evidence that the reforms are achieving many of the intended transformations in the targeted sectors. Priority should go to reforms targeting the rule of law and attendant improvements in security and reduction of corruption. These will not only improve the business environment but are key to the success of existing reform efforts.

At the macro level, productivity is driven by technology and the efficiency of resource allocation, as outcomes of firms’ decision making. The relatively high level of resource misallocation in India’s formal manufacturing sector is well documented. We build on this research to further investigate the drivers of misallocation, exploiting micro-level variation across Indian states. We find that states with less rigid labor markets have lesser misallocation. We also examine the interaction of labor market rigidities with informality which is a key feature of India’s labor markets. Our results suggest that reducing labor market rigidities in states with high informality has a net positive effect on aggregate productivity.

We document that publicly listed Chinese state-owned enterprises (SOEs) are less productive and profitable than publicly listed firms in which the state has no ownership stake. In particular, Chinese listed SOEs are more capital intensive and have a lower average product of capital than non-SOEs. These productivity differences increased between 2002 and 2009, and remain sizeable in 2019. Using a heterogeneous firm model of resource misallocation, we find that there are large potential productivity gains from reforms which could equalize the marginal products of listed SOEs and listed non-SOEs.

Mexico’s robust macroeconomic policy framework has supported moderate growth despite several headwinds in recent years. However, low productivity growth has hindered Mexico’s convergence to higher-income OECD countries and inequalities remain high. These factors call for a renewed strategy to boost productivity and inclusiveness.

This paper examines the variation in life cycle growth across the universe of Mexican firms. We establish two stylized facts to motivate our analysis: first, we show that firm size matters for development by illustrating a close correlation with state-level per capita incomes. Second, we show that few firms grow as much as their U.S. peers while the majority stagnates at less than twice their initial size. To gain insights into the distinguishing characteristics of the two groups, we then econometrically decompose life cycle growth across firms. We find that firms that have financial access and multiple establishments and that are formal, part of diversified industries and located in population centers can grow at sizeable rates.