The Economist

26 The Americas The EconomistJuly 21 st 2018

2

O

NE of the main reasons for the land-

slide victory of Andrés Manuel Ló-

pezObrador aleft-winger inthis month’s

presidential election in Mexico was the

country’s mediocre economy. Between

1995 and 2015 real GDP per person in-

creased by an annual average of 1. 2 % less

than in any Latin American country ex-

cept Venezuela (see chart). Take into ac-

counttheswellinglabourforceandMexi-

co looks even worse: GDP per worker

expanded by just 0 .4% a year while total

factor productivity (a measure of the

economy’s efficiency) barely grew. What

makes thispuzzlingisthatMexicohasem-

bracedeconomicorthodoxy: soundmon-

etary and fiscal policy open trade invest-

ment in education and more recently

improved competition policy.

So what went wrong? In a ground-

breaking book* Santiago Levy the outgo-

ing policy chief at the Inter-American De-

velopment Bank argues that Mexico’s

decision-makers have failed to fix distor-

tions intheeconomycaused bythetaxre-

gime social policy and legal institutions

and in some cases have compounded

them. These distortions lead to a system-

atic misallocation of resources says Mr

Levy a former deputy finance minister

and head ofthe social-security institute.

Inother words workers end upinjobs

where they are less productive than they

might be. Too many individuals who

shouldbeworkersbecomeentrepreneurs

or are self-employed. Efficient businesses

are taxed and penalised while subsidies

help sustain unproductive ones. Joseph

Schumpeter’s notion of“creative destruc-

tion” in which capitalist competition

drives out weaker firms and rewards

stronger ones is paralleled in Mexico by

“destructive creation” quips Mr Levy in

which the environment favours the entry

and survival ofweakbusinesses that hin-

der the growth of stronger ones.

Mr Levy’s powerful argument is based

on hard data. He has had access to detailed

economic censuses conducted every five

years by Mexico’s statistics institute. They

show that Mexico has a huge and dispro-

portionate number of small businesses

and unusually wide variation in the pro-

ductivity of its companies. The census un-

der-counts small firms because it excludes

those that lackfixed premises (such as taco

stands) and those in villages of fewer than

2  500 people. Even so more than 90 % of

the 4. 1 m firms in the 2013 census had at

most five workers. And 90 % of the total

were “informal” absorbing almost 33 % of

the capital stockand 40 % ofworkers.

Rather than “informality” the key dis-

tinction Mr Levy makes is between firms

that have salaried employees and those

that do not. Four-fifths of the “informal”

firms are in the second category: their staff

are either self-employed or paid piece-

rates or profit shares. These firms’ only le-

galobligationistopaycorporate taxofjust

2 % ofrevenues ifthese are under 2 m pesos

($ 105  000 ) a year. Firms with salaried

workers bycontrastmust paysocial insur-

ance deductincometaxandgrapplewith

employment law (which doesn’t allow

them to fire people ifbusinessdrops).

The census shows that firms with sala-

ried workers are much more productive.

So it is worrying that from 1998 to 2013 the

weight of non-salaried firms in the econ-

omy grew. Mr Levy argues that public

policies are to blame. In the name of so-

cial inclusion in the period under study

Mexico introduced non-contributory

pension and health benefits worth 1. 3 % of

GDP thereby helping non-salaried work-

ers while raising income taxes on sala-

riedones tothetune of 1. 9 %of GDP. Never

strongtheruleoflawandenforcement of

contracts have become even weaker.

Mr Levy who designed Mexico’s con-

ditionalcash-transferschemeaimedat re-

ducing poverty has long argued against

erecting further non-contributory bene-

fits inparallel with (ratherthantoreplace)

employment-based social insurance be-

cause this discourages hiring salaried

workers. His book broadens that argu-

ment. Hethinks that Mexicoalsoneeds to

replace restrictions on firing with unem-

ployment insurance and shift the tax bur-

denawayfrompayrolls abolish tax perks

for small firms and take contract enforce-

ment more seriously. The prize would be

faster growth better social provision and

better-paid jobs.

This ought to be attractive to a left-

winger like Mr LópezObrador. The policy

changes are politically daunting but the

new president has a strong mandate. Un-

fortunately he seems wedded simply to

expanding non-contributory pensions

and other benefits. It would be ironic if a

politician who claims to be a mould-

breaker offers more ofthe same.

A misshapen economy

The Mexican puzzle

Source: ECLAC

GDP per person 1995=1 00

70

80

90

100

110

120

130

140

1995 2000 05 10 15

Mexico

Latin America

Venezuela

Bello

WhyMexico has not become more prosperous—and howitcould

..............................................................

(*) Under-Rewarded Efforts: The Elusive Quest for

Prosperity in Mexico IDB.

ruption scheme involving politicians and

businessmen ofall political stripes.

Nonetheless PT loyalists counter that

the judiciary is treating Lula unfairly. He

was convicted of accepting a seaside flat

worth 2. 2 m reais ($ 690  000 ) from a con-

struction firm and in return of encourag-

ing the state oil company to award con-

tracts to that business. Lula swears he is

innocent and thathe never owned the flat.

In a country where only the supreme

court backlogged with 87  000 cases a year

can hear criminal cases against sitting of-

fice-holders—enabling many politicians

accused of massive graft to walk free—

Lula’s 12 - year sentence looks harsh. “We

believe the Car Wash operation is political

persecution against Lula” says Valeska

Teixeira Zanin Martins one ofhis lawyers.

Lula’s supporters also argue that his

punishment has exceeded his sentence. In

2016 the supreme court ruled that people

convicted of crimes could be jailed after

losingan appeal but did not state whether

they retain political rights such as voting

and running for office. Another part of the

constitution protects these rights though

whether they include giving interviews is

up for debate. The judge overseeing Lula’s

sentence prohibited interviews citing the

terms of Lula’s imprisonment and his

probable ineligibilityfor office. Mr Favreto

in contrast tried to free Lula on the grounds

that his incarceration itself violated his po-

litical rights as a potential candidate.

Even ifLula is not on the ballot the PTis

counting on these arguments to bolster its

support. If enough voters believe Lula has

been wronged they may be more likely to

plump for whomever he endorses. In a

contest between the authoritarian Mr Bol-

sonaro and a PT candidate propped up by

outrage over anti-corruption efforts Bra-

zil’s fragile democratic institutions would

be the only certain loser. 7