Why Do Reforms not help deliver growth in México?

MEXICO: How to tap progressNovember 2, 2012

Federal Reserve Bank of Dallas Fausto Hernández Trillo/

CIDE

The most common graph about Mexico’s economic growth

Country

Rates of Economic Growth(selected countries & periods)

Kehoe (2011): China is in another path

Mexico Brazil Peru Spain China Hong Kong South Korea Taiwan Chile0.00

2.00

4.00

6.00

8.00

10.00

12.00

1991-2010 2001-2010

195019521954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008

7

7.5

8

8.5

9

9.5

10

GDP PC Growth rate(Source Penn World Tables)

Growth Factors

1950-1970 1983-20091971-1982

Source: García-Verdú (2007).Buzio and Fazio (2011): updated 2010 and same

direction for the last period

Formal Employment DEFICIT 1995-2011

Migration in period: 6 millions aprox

Jobs Created Necessary Total Jobs Created Formal Labor Deficit

-15,000,000.00

-10,000,000.00

-5,000,000.00

0.00

5,000,000.00

10,000,000.00

15,000,000.00

20,000,000.00

4,506,560.00

17,000,000.00

5,413,485.00

-11,586,515.00

Labor Deficit: annual disaggregation

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011*

-600,000.00

-400,000.00

-200,000.00

0.00

200,000.00

400,000.00

600,000.00

800,000.00

1,000,000.00

1,200,000.00

Creadosnecesarios

High informality in firms

• 90% of firms in Census employ less than 5 workers, 96% less than 10 & only 1% more than 50;• High evasion in registering before IMSS; the most in small firms pequeños.

Size of Firms (# of

workers)

Census IMSS IMSS/Census

Total % in Census

1 – 56 – 1011 – 50

51+

3,312,092224,086149,96837,873

542,064101,231113,45838,713

0.160.450.761.02

0.890.060.040.01

Total 3,724,019 795,466 0.21 1.0

High informality: Labor Force(private), 2008*Size of Firms Formal Informal Total

Panel A: Urban employment in Census 1 – 5 596 8,174 8,770 6 – 10 733 981 1,714 11 – 50 2,731 1,060 3,791 50+ 4,665 687 5,352 Total 8,725 10,902 19,629

Panel B: Urban Employment not captured in Census Self-employment 9 4,064 4,073 2 – 5 213 6,015 6,228 6 + 1,517 1,403 2,920 Total 1,739 11,482 13,223

Panel C: Rural Employment not captured in Census ** 283 5,354 5,638

Total 10,747 27,738 38,485

*Thousands of workers; **Distribution by size not available.

•Census underestimates economic activity•Even in the census, informality is high •Informality is inversely correlated with firm size•Most un-captured information is informal (panels B and C). •72% of private employment is informal,•This table complements the previous one and suggests informal employment takes place in establishments with no specific location

In sum: The Fact The question The Answer

Mexico does not growth

according to its level of

development

Why? No one knows…there is no consensus,

economists and analysts all

disagree

High vulnerability to external shocks Volatility of “Public Policy” and pro-ciclical Low rates of savings and investment (public & private) Deficient infrastructure Low quality of education, which negatively affects labor productivity and income

distribution Deficient legal and intitutional frameworks (Judicial System very procedurial);

property rights protection Weak economic competition Influential Pressure groups, which deter reforms Weak social capital, which generates lack of trust in government and civil

institutions (Putnam, 2001, IADB) Lack of credit access, especially for Small and medium firms Labor market distortions, “Structural” Reforms (Fiscal, Energy and Labor) Etc.

Reasons: Most mentioned in literature, among many others

All of them would call for more Reforms

Reforms have been incomplete and furthermore insufficient Reforms have gone too far and they have been unable to remove

the power of pressure groups (private, public or unions) Those were not the appropriate ones in the first place Reforms were introduced in the middle of a crisis, then they were

not planned adequately. They were poorly implemented They were designed to just meet the “international

recommendation” (thus introduced as a movie set) Some other reforms were not even recognized and thus

attempted (such as the judicial –with an economic sense) Sequence was incorrect Divided governments became an obstacle. There has never been a consensus about the direction of the

reforms

Why have reforms not delivered?Most recurrent arguments

The truth is that society suffers from a “Reform Fatigue Disease” (Esquivel & Hdez, 2010).

Around 400 “reforms” have been introduced in Mexico during the period 1988-2010.

Why have reforms failed?

It depends.

If they are clearly stated, addressing tangible benefits & costs, not that optimistic (one sole reform is not a panacea), and attending the real root of the problem (TFP), they may have a chance

Can Mexico formulate more reforms?

Let’s use Fiscal Reform as an example:

It is a mean not an end (it is just an instrument to accomplish “something”)

The positive aspect: it has been effective in keeping macro stability, though this has been possible thanks to oil revenues

“Capital-Sins” OF FISCAL POLICY:

1. Prociclical2. Low tax collection, given the resposabilities of the

government 3. No redistributive  4. Furthermore, opaque, not subject to accountability in a

broad sense (performance and transparency)

Why is a Fiscal Reform necessary?

Why is a Fiscal Reform necessary?

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%19

8019

8119

8219

8319

8419

8519

8619

8719

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

10

Ingresos tributarios GF Gasto neto GF

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

-0.1

%

-2.3

%-0

.7%

2.0%

1.6% 2.

0%

2.7%

4.7% 5.

2%

5.9%

5.1%

6.8%

6.5%

2.5%

1.9%

2.5%

3.0%

2.1%

0.8% 1.

1% 1.6% 1.7%

0.2%

0.9%

0.9%

0.8%

0.1%

-0.2

%

0.1%

-0.0

4%

-0.7

%

Why is a Fiscal Reform necessary?

Primary Balance: including oil revenues, %GDP

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1.87

%

3.77

%

3.71

%

-0.0

2%

-0.0

8%

-0.6

8%

-0.7

8%

-1.4

0%

-1.3

2%

-0.6

8%

-1.6

9%

-1.2

9%

-1.8

7%

-2.4

7%

-3.2

5%

-4.3

1%

-5.4

4%

-5.1

3%

-7.3

9%-4

.16%

-5.1

%

Primary Balance: excluding oil revenues %GDP

Why is a Fiscal Reform necessary?

Reiterating: It is just an intrument, not a final objective (not an end itself)

“But” every fiscal reform should have a raison d’etre

Source: Antón, Hdez & Leal (2012)

Sole VAT increase

Let’s consider Social Policy as an example of an intention to change public policy (as the end)If previously well-designed, then a fiscal reform would be only the instrument to finance it (Levy, 2008)

Status Quo versus Social Reform Proposal

ItemStatus quo

SSUFormal Informal

Medical Insurance XXXXX XXX XXXXX

Life and disability

Insurance yes No yes

Work risk yes No Contribution

Pensions All

All in Opotrunidades

registries and some

states

All

Childcare Yes yes No

Housing yes Yes No

What is the allegeded Social Policy Consecuence?

Mmmm… I have to pay contributions to have access to health system, a pension system, day care and so

on…

Gee… I do not have to pay any contribution and

still will have access to health system, pension, day care, etc…

Formal Sector (Salaried worker)

Informal Sector (Salaried worker)

Look!She is

walking out,

She just resigned to her formal,

salaried job!

Here there are two conflicting objectives:

1. Social Equity (through social services coverage)

2. Financial Equity

This reduces financial gap between them and thus reduces the incentives to participate in the contributive-formal system (Levy, 2008)

The cost of a prevailing dual social policy

Empirical Results Recent literature:

◦ Juárez, Scott, Parker, Pagés, Bosch, Campos, Duval, Heckman, Morales, etc.

◦ Mixed results. However as time goes by, results have a tendency to support the hypothesis, though no that high

◦ Antón, Hdez, Levy (2011); Harding y Pagés (2011); Morales (2011) Unger and Unger (2012) provide a positive impact.

◦ Pagés (2012) surveys all literature and conclusion is that there is a marginal (but statistically significant) effect (1 per cent, i.e. 400,000 per year! That is, marginal in % terms but in absolute terms is one third of the jobs Mexico needs to create yearly).

◦ We need, however, further evidence

Proposal*: IMSS-Type Universal Health Care

Universal minimum (2mmw) Pension

NO-CONTRIBUTIVE

*Essentially same as Narro (2009), Cordera (2006) & Jusidman (2009) the justification is or might be different but there is some consensus abouth this

How to finance it?:VAT and…? Uniform VAT

◦ This time, as there is tangible benefit, the proposal might be approved @ Congress

◦ Tangible Benefits (among many others) Anton et al (2011) show that wage in formal and

informal sector (though much larger for the first one) rises

As the health care will be IMSS-type, benefits increase for all population (as oppossed to SP)

Gasoline prices (free mkt price)

Special tretaments corporate and personal tax

Aggregate Effects of the Levy (2008) proposalVariable Value relative to benchmark

Main AggregatesY 1.025K 1.015

TFP 1.02Occupational choices

Employee share 1.128Self-employment share 0.736Full entrepreneur share 0.811

EarningsWage informal 1.148Wage formal 1.212

Av. earnings Self-emp. 1.135rK/Y 0.99

RevenueRevenue VAT 1.247Revenue CSI 0

Total Revenue 0.835Price of sector 1

p1 1.051

TFP effects: USS with VAT increase

Source: Antón, Hdez & Leal (2012)

Total Balance SSU

AlternativeCost Total 4.99What it is already spent 1.76Extra amount needed 3.23Extra VAT collection 3.42Compensations to 1st quintil 0.24Balance -0.05

Wage increase for formal and informal workers

Financial resources channeled to Afores go from 72.4 a 192.8 mmp (or 166%), equivalent to 1% of GDP.

Productivity increase (working on this…) Preliminary estimates: extreme poverty is

reduced by half and moderate by 30 % (from 45 to 33%) and

Reduce income inequatlity (Scott, 2012)

Possible Benefits

Thank you very much !!!