Mexico’s economic reforms take hold

Many of Mexico's small businesses don't pay taxes – or worker benefits, but more workers are stepping into formal jobs with steady paychecks indicating growth in the economy overall.

Progress Watch

Tamale tables, strawberry stands, street food vendors shaded by big umbrellas – these are all part of a quintessential image of Mexican culture. The problem: Most of these tiny businesses, which make up a large piece of Mexico’s informal economy, don’t pay taxes. Neither do they offer their workers benefits.

It’s a system that deprives workers of essential needs and also inhibits overall economic growth. 

But now, five years after key fiscal and labor policy reforms were put into place, the nation’s formal sector – including manufacturing and services – is beginning to grow. In the first half of 2017, a record number of workers joined Mexico’s formal economy and were registered with the Mexican Social Security Institute, according to the institute’s numbers. The uptick of 517,000 workers marks a 17 percent increase from last year, the biggest jump in two decades.

But these jobs aren’t appearing out of nowhere. Many of them are transitioning out of the informal economy as employers offer work contracts with employee benefits, experts say. With formal jobs on the rise, the informal sector has dropped to 57.3 percent of Mexico’s workforce, from its peak of 60 percent in 2009, reports Bloomberg.

These numbers show that “there actually is a transition occurring where a greater share of work is being done ... in the formal sector,” says Christopher Wilson, deputy director of the Mexico Institute at the Wilson Center in Washington, D.C. This recent growth is part of a larger trend. “Since 2014, there have been over 2 million jobs created in the formal sector in Mexico,” Mr. Wilson says.

This growth is good news for Mexico, according to Antonio Ortiz-Mena, a Latin American trade and economics expert at the Albright Stonebridge Group in Washington. “[Formalization] is absolutely essential for Mexico’s future,” says Mr. Ortiz-Mena, who is also an adjunct professor at Georgetown University’s Edmund A. Walsh School of Foreign Service in Washington.

When companies are informal, they “get stuck in low productivity levels,” which makes it “very hard to increase wages in a way that they’re not inflationary, or to increase overall [gross domestic product],” he explains.

Decades of widespread corruption – and subsequent public mistrust in government and banks – have fostered the independent spirit that drives a majority of Mexico’s mom and pop businesses, but economic experts liken this to an economy spinning its wheels.

Companies with at least 500 employees may only account for 20 percent of Mexico’s workforce but those businesses were responsible for 44 percent of Mexico’s productivity in 2009, according to a 2014 McKinsey Global Institute report.

On the other hand, businesses with 10 or fewer employees accounted for 42 percent of Mexico’s workforce but only 4 percent of Mexico’s productivity. Informality is not only inefficient – it’s “a lag on social progress,” Ortiz-Mena says. “[Workers are] caught in this vicious cycle. [They are] ... working a lot and making very little,” he says.

Job formalization means that wages increase, jobs are secured, and people become more willing to spend money, Wilson explains. In recent years, Mexicans have spent more money in their local economies, with domestic spending growing about 4 percent in 2017 alone, Bloomberg reports. “While that’s down from last year’s pace, it’s still double the estimated overall growth for the Mexican economy this year.” 

Both Wilson and Ortiz-Mena attribute this progress to successful policy reforms.

Labor reforms passed in 2012 provided “more options for setting short-term contracts,” thereby reducing the risk of taking on new employees and making hiring and firing more flexible, Wilson says.

The fiscal reform, passed in 2013, helped introduce smaller enterprises to the formal economy, thereby reducing tax evasion and increasing tax revenue, Wilson says. Companies that start to formalize “immediately have access to some of the benefits of formality,” such as being eligible for bank loans and giving their workers pensions. 

Down the road, Mexico’s formalization could affect US-Mexican labor relations, Ortiz-Mena suggests. If higher wages became a broader reality in Mexico, there could be “[fewer] incentives ... to risk life and limb crossing the [US] border without documents.”