Big Business: How More Mexican Firms Can Benefit from Scaling Up
As thriving businesses are good for economies—helping to create jobs, spur productivity, and raise incomes— it is critical that firms are able to expand to reap the benefits that come with size.
In our latest research in a staff Working Paper, we looked at how Mexican firms have grown over time, and found that the majority of firms likely do not grow enough to reap the full benefits from scaling up their operations.
According to the paper, the vast majority of firms have not been able to even double in size some 25 years after their establishment. This is very little growth compared to advanced economies, such as the U.S., especially since most firms in Mexico start with only one or two employees.
The good news is that some firms do defy the odds—growing continuously throughout their lifetimes. We can explain much of the gap between these superstar firms and their peers with a small set of policy challenges.
Firm size and economic development
So, why does it even matter that firms grow? The answer is that there is a strong positive association between firm size and income levels across countries that is well documented in previous studies.
The intuition behind this link is that firms that do not grow often fail to do so due to a lack of productive investment. Further, firms that remain small cannot take advantage of economies of scale in their operations.
Our work shows that the same link exists within Mexico—the larger the average firm in a given state, the higher the state’s per capita income level.
Firm lifetime growth
An important empirical finding that we confirm in this analysis holds that Mexican firms grow very little over their lifetimes.
At the same time—taking a closer look—it appears that a small share of high performing firms does grow strongly and continuously. While even firms among the top 10 percent of firms in terms of lifetime growth only double in size, the firms in the top 1 percent grow to some five times their initial size (eight times in the case of manufacturing firms) which exceeds the growth rates observed for the average firm in the United States.
Who are these superstar firms? A simple disaggregation by size and industry tells us that they tend to be very large, and that they tend to be part of industries involved in the North American supply chains. For example, they include the manufacture of cars and car parts and communication equipment as well as transport industries that support both internal and external trade.
Could this be bad news in that it implies that only large firms with access to the North American supply chain can grow fast? Not necessarily. Our analysis shows that regardless of size and industry, Mexican firms can grow at sizable rates as long as they overcome a set of challenges. These include formalizing their operations and gaining access to finance, as well as to markets in major population centers. It also helps to have multiple establishments from the outset and to be part of a relatively diversified industry.
To give a sense of the economic relevance of our findings, the analysis predicts that a firm that is both formal and has a bank account would see a cumulative growth rate some 140 percentage points higher than an informal firm without financial access.
From a policy perspective, our findings emphasize the need for continued structural reforms. This includes efforts to reduce informality and tax evasion, limit the use of market power in concentrated industries, and strengthen access to financial services.
Furthermore, targeted infrastructure investments can help to better connect the more remote regions to the major population centers in the country.