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Mexico may be one of the top targets for U.S.-based multinationals looking to manufacture closer to home, but a divided economy may be preventing the country from enjoying broader economic gains, according to a new report from the McKinsey Global Institute.
The problem is that much of Mexico's job growth is still coming from "traditional" companies based in the country, which tend to have lower levels of labor productivity than modern companies, according to the report. In fact, the traditional segment has accounted for 48 percent of the job growth in Mexico since 1999.
Small traditional companies, as defined in this report, are companies that employ 10 or fewer people, often low-skilled laborers at lower costs. For example, many of the local subcontractors that assemble components such as wire harnesses for auto manufacturers are traditional and have one-tenth the productivity of the modern parts suppliers for which they work.
Couple that with the fact that productivity from small, traditional establishments has been declining in recent years – down 6.5 percent a year since 1999, and it becomes clear why this is such a big issue for the Mexican economy.
Mexico's GDP has averaged growth of 2.7 percent since 1990, with labor inputs accounting for more than two-thirds of that growth. In 2009, traditional companies employed 42 percent of the labor force, but only contributed 10 percent to the overall economy.
These traditional companies are less likely to be able to invest in the equipment and technology improvements needed to improve productivity, McKinsey says. And many may operate outside of the formal economy – meaning they don't contribute to the country's broader economic growth.
But this economic dichotomy could actually provide economic opportunity for Mexico, if it takes action soon. "Mexico must create a business environment that encourages entrepreneurship and growth and removes economic incentives for businesses to remain small and informal," the report says.
While Mexico is one of the top 15 global manufacturing countries – thanks in large part to the automotive and aerospace sectors – that won't be enough to continue growing Mexico's economy going forward if current trends continue, the report says. To keep Mexico on a growth trajectory, the government has to begin focusing on building up those traditional enterprises and not just on bringing in the large, modern companies to boost economic output.