Locked in Low Gear: Mexico’s Struggling Economy

 Mexico’s economic growth performance is characterized as being "locked in low gear," marked by persistent underperformance and a recent downward trend in growth rates.

Long-Term and Recent Growth Trends

• Historical Average: Since 1990, Mexico’s average economic growth has remained stagnant at approximately 2.2% per annum.
• Recent Decline: Between 2018 and 2024, the average growth rate dropped further to approximately 0.9%, representing the lowest levels seen since the 1980s.
• Current Status: In 2025, growth stood at only 0.8%, and current forecasts for 2026 indicate that the trend will continue with growth expected to not exceed 1.3%.

Structural Barriers to Growth

The sources argue that this poor performance is driven by deep-seated structural factors rather than temporary fluctuations.

• Informality and Productivity: Approximately 54.4% of the workforce operates in the informal economy, which generally lacks the capital, skills, and technology necessary for high productivity. This disparity is stark; while the formal sector employs less than half the workforce, it generates 74.6% of the country’s total GDP.
• Declining Investment: Both public and private investment have struggled, with public spending on fixed investment decreasing by 28.4% in 2025. Gross fixed investment saw a 7% year-to-date decline through November 2025, a contraction typically seen only during major economic recessions.
• Fiscal Rigidity: The federal budget is increasingly rigid, with 70% of tax revenue in 2025 committed to social programs, pensions, and debt servicing, leaving very little for infrastructure, education, or health. Consequently, the national debt is projected to approach 60% of GDP by 2030.
• "Sticky" Inflation: Inflation remains above the central bank’s 3% target, reaching 3.79% in January 2026, which restricts domestic consumption and hampers short-term growth.

Institutional and External Influences

• Structural Reforms: Recent judicial and regulatory reforms—such as making all judges popularly elected and dissolving independent regulatory agencies—have introduced considerable uncertainty for investors, likely reducing the flow of capital into the country.
• Trade Vulnerabilities: While Mexico benefits from the USMCA, it is heavily dependent on the United States, with 83% of goods exports sent there. Shifts in trade, such as the decline in automotive exports relative to computer equipment, may offer less economic stimulus because computer manufacturing often involves transshipment with fewer domestic jobs and lower capital expenditure.
• Public Insecurity: Private sector economists currently rank public insecurity as the primary factor threatening economic growth, surpassing concerns about foreign trade policy.

The sources describe Mexico as an economy operating at two very different "speeds," where the stark divide between the formal and informal sectors acts as a primary structural barrier to national growth.

The Productivity Gap

The most significant issue highlighted is the massive disparity in productivity between the two sectors.

• Workforce Distribution: As of 2024, approximately 54.4% of Mexico’s workforce operates in the informal economy.
• GDP Contribution: Despite employing more than half of all workers, the informal sector contributes only 25.4% of the country’s total GDP.
• The Formal Powerhouse: Conversely, the formal sector—which comprises only 45.6% of workers—generates 74.6% of total GDP.

Informal workers are generally less productive because they lack the necessary capital, skills, and technology to integrate into the modern economy, and they do not benefit from standard employment protections.

Drivers of Increasing Informality

The sources suggest that the informal sector is currently expanding due to several domestic pressures that are pushing businesses and workers out of the formal economy:

• Regulatory and Tax Pressures: Aggressive revenue collection practices have led many small businesses to transfer their activities to the informal sector to avoid the tightening fiscal environment.
• Rising Labor Costs: Significant minimum wage increases (rising over 145% in real terms since 2018) and constitutional reforms—such as reducing the work week from 48 to 40 hours—have increased business costs without a corresponding gain in productivity.
• Public Insecurity: There is a strong hypothesis that organized crime and extortion are driving small- and medium-sized enterprises (SMEs) to operate "underground" to reduce their visibility to criminal groups.
• Judicial Uncertainty: Recent judicial reforms are expected to increase litigation costs, potentially making the formal market too expensive for mid-sized firms, further encouraging a migration to the informal sector.

Broader Economic Consequences

This high level of informality creates a damaging cycle for Mexico’s struggling economy. Because a majority of workers are in an untaxed sector, the government’s ability to raise revenue is severely limited. This results in:

• Underinvestment: There is insufficient funding for vital growth drivers like infrastructure, education, and science and technology.
• Fiscal Rigidity: With a limited tax base, the federal budget has become extremely rigid, with 70% of tax revenue already committed to social programs, pensions, and debt servicing.
• Declining Formal Employment: In 2025, Mexico saw a decline in formal job creation, with the number of employers registered with the Mexican Social Security Institute (IMSS) contracting for 19 consecutive months as of early 2026.

The sources conclude that without addressing these structural barriers—particularly the lack of investment in skilling and infrastructure that would allow informal workers to transition—Mexico will remain "locked in low gear".

Mexico’s workforce productivity is a critical structural barrier that keeps the economy "locked in low gear," with the country currently ranked near the bottom of the OECD productivity list, followed only by Colombia.

The Informal-Formal Productivity Gap

A major driver of low national productivity is the deep divide between the formal and informal sectors.

• Concentration of Labor: The informal sector employs 54.4% of the workforce but contributes only 25.4% of Mexico’s GDP.
• Efficiency Disparity: In contrast, the formal sector employs just 45.6% of workers but generates 74.6% of the country’s total GDP.
• Barriers to Integration: Informal workers are significantly less productive because they generally lack the capital, technology, and advanced skills required to integrate into the modern economy.

The Wage and Productivity Mismatch

The sources highlight a growing "gap" between rising labor costs and stagnant output that threatens Mexico's competitiveness.

• Rising Costs: Since 2018, the real minimum wage has increased by an average of 13.02% per year.
• Declining Output: During the same period (2019–2024), labor productivity actually diminished by an average of 0.04% per year.
• Impact on Businesses: This disconnect increases operating costs and discourages investment, particularly for small- and medium-sized enterprises (SMEs) that cannot absorb these costs without corresponding productivity gains.

Underinvestment as a Structural Constraint

Mexico's low productivity ranking is attributed to significant underinvestment in three key areas: education and skills, technology and innovation, and infrastructure.

• Fiscal Rigidity: Productivity remains stunted because the federal budget is highly rigid, leaving little flexibility to shift resources toward strategic sectors like education or science and technology.
• Infrastructure Deficits: A lack of investment in basic infrastructure—such as power grids, water systems, and highways—increases business costs and further diminishes total productivity.
• Declining Efficiency: In 2024, Total Factor Productivity (TFP), a measure of structural efficiency and innovation capacity, contracted by 0.35%.

Consequences for the Struggling Economy

The sources conclude that these productivity challenges create a damaging cycle for the broader economy. Reduced productivity compromises worker well-being, limits the national tax base, and jeopardizes long-term GDP growth. Furthermore, as productivity fails to keep pace with wage increases, Mexico risks losing its status as a competitive manufacturing hub and its potential to remain the United States’ most important trading partner. To unlock the economy, the sources recommend channeling resources away from consumption-based social programs toward skilling programs and critical infrastructure to boost future output.

The investment landscape in Mexico is currently characterized by a cycle of underinvestment and economic doubt, which the sources identify as a primary structural factor keeping the country’s economy "locked in low gear".

General Investment Trends

• Stagnant Growth: Mexico has faced a lack of both private and public investment since 2016. While there was a temporary uptick at the end of the previous administration to complete major infrastructure projects, recent productive investment has failed to meet expectations.
• Declining Fixed Investment: Gross fixed investment, which includes both public and private sectors, saw a 7% year-to-date decline through November 2025. This level of contraction is historically associated only with major economic recessions, such as those in 1995, 2009, and 2020.
• Public Sector Reductions: Public spending on fixed investment plummeted by 28.4% in 2025, the largest reduction since 2021. Although the 2026 budget proposes an increase, it remains below 2024 spending levels.

Foreign Direct Investment (FDI) Shifts

While total FDI for 2025 reached $40.87 billion, the underlying data reveals a "subdued" and concerning trend:

• Record Divestment: The fourth quarter of 2025 saw a net divestment of $5.02 billion, the first such occurrence on record.
• Collapse of New Investment: New investments accounted for only 18.05% of total FDI in 2025, a sharp decline from the 45–50% levels seen just a few years earlier in 2021 and 2022. Most current FDI is driven by the reinvestment of profits (brownfield) rather than the entry of new companies (greenfield).
• Strategic Gaps: Despite high U.S. demand for computer equipment, this has not yet translated into increased FDI in that sector, suggesting Mexico is failing to capitalize on robust U.S. investment trends.

Barriers and Deterrents

The sources highlight several domestic and external factors that have created a climate of "economic doubt":

• Public Insecurity: Private sector economists rank public insecurity as the top factor threatening growth, surpassing concerns about foreign trade. Uncertainty regarding organized crime and extortion is even pushing some small businesses to move their operations "underground".
• Institutional Reforms: Reshaping the judicial system—making judges popularly elected—and dissolving independent regulatory agencies have introduced considerable uncertainty for investors. Investors now face a weakened ability to fairly appeal government decisions.
• Energy Sector Constraints: The government’s decision to restrict private investment in strategic sectors like energy and power generation acts as a "structural brake" on growth. Without reforms to invite private capital, Mexico may struggle to meet the energy needs of new investors.
• Trade Uncertainty: Companies are currently in a "holding pattern" due to uncertainty regarding U.S. tariff policies and the upcoming 2026 USMCA review.

Investor Sentiment and Outlook

As of December 2025, 49% of private sector forecasters considered it an inopportune time to invest in Mexico, and 51% were uncertain. Notably, zero respondents viewed it as an advantageous moment. The sources conclude that unless Mexico restores legal certainty, opens its energy markets, and shifts its budget from consumption toward productive infrastructure, the types of investment needed to unlock the economy are unlikely to materialize in the near term.

The sources indicate that Mexico is facing a declining fiscal position characterized by extreme budgetary rigidity, rising debt levels, and a shift in spending toward consumption rather than productive investment.

The Rigidity of the Federal Budget

The central challenge identified in the sources is that the Mexican government has very little flexibility to manage its finances.

• Committed Revenue: In 2025, 70% of all tax revenue was already committed to social programs, pensions (both contributory and noncontributory), and debt servicing.
• Crowding Out Strategic Sectors: This rigidity leaves only a small fraction of the budget for vital sectors that drive long-term growth, such as health care, education, infrastructure, and science and technology.
• Ineffective Spending: While social programs and pensions provide liquidity, the sources argue these funds are largely used for consumption, which does not contribute to sustainable, long-term economic growth.

Rising Debt and Deficits

Despite efforts to collect more revenue through aggressive tax enforcement, Mexico is struggling with an expanding budget deficit.

• Debt Thresholds: The gross debt-to-GDP ratio reached 55.8% in 2025 and is projected to approach 60% by 2030. Crossing this 60% threshold is viewed as a critical point that may lead international markets to view Mexico's fiscal position negatively.
• Nonproductive Borrowing: A major concern raised is that additional debt is being used primarily to finance current expenditures and nonproductive investments rather than mid- or long-term productive projects.
• Fixed Investment Declines: Public spending on fixed investment dropped by 28.4% in 2025. While the 2026 budget proposes an increase, the sources warn that the target remains at risk because the government’s revenue and expenditure assumptions are likely overvalued.

Subsidies to State-Owned Corporations

Budgetary pressure is further exacerbated by the government’s commitment to state-owned enterprises.

• Pemex and CFE: Substantial resources are drawn from the federal budget to subsidize the national oil company (Pemex) and the national power utility (CFE).
• Discouraging Private Capital: Current regulatory conditions disincentivize private investment in the energy sector, leaving the government to shoulder the massive costs of meeting the country’s energy demands alone.

Broader Economic Risks

The sources conclude that this fiscal environment acts as a "structural brake" on the economy. The budgetary rigidity not only limits economic growth but also heightens the risk of credit rating downgrades. To unlock the economy, the sources recommend a major revision of budget priorities, specifically channeling resources away from cash transfer programs toward skilling, critical infrastructure, and health care to boost future productivity.

The sources indicate that Mexico's economic performance is significantly hindered by a combination of internal social challenges and external trade-related vulnerabilities, both of which serve to keep the economy "locked in low gear".

Social Barriers: Insecurity and Inequality

The most prominent social barriers involve the impact of crime on business operations and the structural limitations of the domestic market.

• Public Insecurity and Organized Crime: Between December 2025 and February 2026, private sector economists ranked public insecurity as the primary factor threatening Mexico’s economic growth, even surpassing concerns about foreign trade. There is a strong hypothesis that organized crime and extortion have forced many small- and medium-sized enterprises (SMEs) to move their operations "underground" to the informal sector to reduce their visibility to criminal groups. Furthermore, recent judicial reforms that make judges popularly elected are viewed as a risk that could open the judiciary to the influence of organized crime.
• Persistent Labor Informality: Approximately 54.4% of the workforce remains in the informal economy. This sector is characterized by low productivity because workers lack the necessary capital, skills, and technology. This high level of informality creates a cycle where the government cannot raise enough tax revenue to invest in strategic social areas like education, health care, and skilling programs, which are essential for long-term growth.
• Weak Internal Market: While domestic consumption represents about 71% of Mexico’s GDP, it is described as "volatile". Growth is limited because income and wealth are unevenly distributed, and most households rely on subsidies and remittances just to maintain basic consumption rather than increasing their spending power.

External Barriers: U.S. Overdependence and Trade Risks

Mexico’s economy is defined by a state of "asymmetric interdependence" with the United States, which provides significant advantages but also creates extreme vulnerability.

• Extreme Export Concentration: Mexico is heavily dependent on the U.S. market, which receives 83% of its goods exports. Over the last decade, nearly 40% of all Foreign Direct Investment (FDI) has come from the U.S.. This overexposure means that shifts in U.S. commercial policy, such as protectionist tariffs or trade threats, have a disproportionate impact on Mexican economic stability.
• The "Holding Pattern" of Uncertainty: Uncertainty surrounding the 2026 USMCA review and shifting U.S. tariff schedules has placed many investors in a "holding pattern". This has led to a collapse in "greenfield" (new) investment, with most current FDI coming only from the reinvestment of existing profits.
• Trade-Offs in Export Sectors: In 2025, computer equipment overtook automotive exports as Mexico's top export to the U.S.. However, the sources note this as a negative structural shift; while the automotive industry is deeply integrated and drives domestic jobs and productivity, the computer sector involves a high degree of transshipment, which generates less economic spillover and fewer domestic jobs.
• Pressure Regarding China: To mitigate pressure from Washington regarding China's potential use of Mexico as a "backdoor" to U.S. markets, Mexico imposed a 50% import tariff on over 1,400 goods from countries without trade agreements, specifically targeting China. While intended to raise revenue and protect trade relations with the U.S., these tariffs are expected to increase costs for Mexican industries that rely on Chinese intermediate inputs.