Boosting Growth Potential

Sean Dougherty

Slow income growth in Mexico has prevented its convergence to the average income levels of OECD countries. To strengthen growth potential, structural reforms are needed that will boost investment and reverse the trend of negative productivity growth that has undermined gains in well-being. Key reforms called for include boosting human capital, making labour markets more flexible and more formal, removing restrictive barriers to entry to different economic sectors, and improving the quality of the judiciary. Strengthening competition is an urgent objective that could likely yield the most front-loaded benefits. Also needed are institutions capable of ensuring that the reforms agreed are effectively implemented. This will require improvements in the legal framework and political commitment to reform. many of the commitments contained in the Pact for Mexico pursue these purposes, but their full and coherent implementation is a requisite for greater growth.

.^Although its GDP per capita is one of the lowest among OECD countries, Mexico has many strengths that it can draw upon to generate growth: a stable macroeconomic environment; a high degree of trade openness; proximity to the largest economy in the world; a young population; and ample natural resources. it has also made considerable progress in education and health coverage and in enhancing competition, and has one of the most innovative poverty reduction programmes in the world. Still, important bottlenecks remain that prevent Mexico from reaping the full fruit of such assets. As a result, overall economic performance has been disappointing over the past decade, especially in terms of productivity (though some improvement has been recorded since 2010).

the gap between Mexico’s living standards and those of middle-range OEcD economies is almost entirely due to lower levels of labour productivity. To reduce that gap, mexico needs a reform agenda to boost productivity and remove the obstacles that have hampered its dynamism over the past decades. This is made all the more urgent by growing competition from other economies.

most worrying is that multifactor productivity growth has been negative over the past decade (Figure 1.1), leading to an income growth of only 1.2% per year. During this period Mexico’s GDP per capita growth was insufficient to significantly narrow the income gap with the leading OEcD countries. This low productivity growth contrasts with major emerging markets, where productivity growth was sufficient to significantly boost incomes. In fact, in Brazil, Chile, South Africa and Turkey, incomes increased at a speed two or three times faster than those in Mexico. In China, India and Russia, incomes rose even faster.

The OECD estimates that Mexico’s potential GDP growth rate is presently just above 3% per annum, though actual growth has averaged 4.5% following the great recession in 2008-09, as the economy recovers its longer-term growth path (Figure 1.2). Two percentage points of growth are the contribution of favourable demographics - given Mexico’s youthful population. However, this advantage is set to decline in the coming years, though it will remain positive. Another 1 percentage point of growth comes from gains in human capital, i.e. rising education levels, which can help to make up for the declining gains from the “demographic bonus”. The additional capital per worker adds another percentage

Figure 1.1. Negative productivity growth has meant slow income growth

Source: OECD Economic Policy Papers No. 3, "Looking to 2060: Long-term Growth Prospects for the World", forthcoming b.

point, but this is offset by a similarly large negative contribution of multifactor productivity.

Productivity-enhancing structural reforms could substantially boost the pace of growth in the coming years and accelerate convergence with the OECD countries (see Figure 1.2). A moderate course of reform would raise Mexico’s potential growth to around 3.5% annually in the medium term, though demographics will cause it to slow as the old age population increases. This could be partially offset if migration flows substantially reverse, or if education quality rises faster than the number of years of schooling.

With a more ambitious course of reform, growth rates could be lifted even further, to a rate approaching 4% per cent annually in the medium term - or even higher if sufficiently ambitious, as the new government hopes in its Pact for Mexico. This however requires Mexico to go well beyond the OECD averages, and implement reforms that mirror the best-performing OECD economies. Such an ambitious course of reform would help lift per capita incomes more than twice as quickly - from about 30% of the United States at present to close to half of the US level by the end of the projection horizon. A large proportion of this faster catch-up would likely come from competition reforms, though reforms in multiple areas would be needed to be carried out over a similar period to achieve an even higher growth path.

Figure 1.2. GDP growth potential under different reform scenarios

Source: OECD Economic Outlook database and OECD calculations.

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