In December 2024, a delegation of scholars affiliated with the Hoover Prosperity Program travelled to Mexico for a series of meetings aimed at understanding why economic growth has stagnated within Mexico and many other Latin American countries as well as what a path to prosperity in the region might look like.
The goal of the recently launched Hoover Prosperity Program, led by Peter and Helen Bing Senior Fellow Stephen Haber, is to advance the state of knowledge so that citizens and public officials can make informed decisions about a core question: What set of laws, policies, and regulations is most likely to insure a prosperous future?
While much of the program's research focuses on the United States, the search for answers on how to encourage long-term economic prosperity necessarily includes analyses of developing economies.
One salient question, which has long been a focus of Haber's research, is why prosperous economies develop in some countries and not in others. This question is especially relevant in Latin America, which has some development success stories in Chile and Uruguay but has failed to reach full economic potential elsewhere.
The capstone event of the trip was a conference organized with the Center for Economic Research and Teaching (CIDE), one of Mexico's leading centers of higher education in economics and political science as well as a leading think tank in the country. The conference, "The Middle-Income Trap in Latin America," was held at CIDE's campus in Mexico City and featured presentations from Hoover and CIDE scholars on Mexico's economy and the economic development challenges facing middle-income counties.
The impact of Latin America's geography on the region's economic development
In the first session of the conference, Haber began his remarks by asking, "Why did Latin American economies, despite growing in the twentieth century, not converge with the US’s?"
He and his coauthors, Jordan Horrillo and Roy Ellis, look to Adam Smith’s seminal theory from The Wealth of Nations for a framework to analyze this question. Smith posits that geographic factors like navigable waterways, natural harbors, and fertile soils critically influence the extent of markets and, by extension, economic development.
By incorporating modern geospatial analysis and considering eighteenth-century transportation and agricultural technologies, Haber and his coauthors confirmed the validity of Smith’s claims in explaining the patterns of economic prosperity that we see across the globe today.
To demonstrate his point, Haber compared the extent of potential markets—measured by the theoretical reach of pre-industrial trade networks around cities—of Mexico City and Paris circa 1790. The potential market of Paris was 80,000 square miles with eighty-nine harbors, compared to Mexico City's, with 13,500 square miles but zero harbors.
Prior to the industrial revolution, the larger potential for trade in Paris—along with the rest of Western Europe and the United States, thanks to their plentiful navigable rivers and flatter topography—led to the development of institutions more conducive to economic growth, facilitating the exponential gains that were made possible through the technologies that developed post-1850s. Haber concluded that, in short, geography gave Western Europe and the United States an advantage over Mexico and most of Latin America.
Free trade and developing economies
Mateo Hoyos (CIDE) presented a paper in which he explored the nuanced relationship between trade liberalization—specifically tariff reductions—and economic growth, highlighting how this relationship varies significantly depending on a country’s economic structure.
Using a dataset spanning 161 countries from 1960 to 2019, Hoyos investigated the medium-term effects of tariff reductions on income per capita. His findings revealed that while tariff reductions are associated with higher income growth in manufacturing-oriented economies, they correlate with lower income in economies without a strong manufacturing base.
He also found that manufacturing-heavy countries strengthen their industrial bases after tariff reductions while non-manufacturing countries see a decline in their manufacturing sectors’ share of GDP in the face of increased foreign competition.
While economists generally tout the benefits of free trade for all parties, Hoyos pointed out that the gains are not necessarily distributed evenly.
How do countries get trapped in middle-income status?
Taking on the conference’s central question, Avidit Acharya (Hoover Institution) presented a theory describing the conditions under which poor countries ruled by a dictatorial regime can develop into middle-income countries through taking partial measures toward economic liberalization. However, operating in a system with selectively applied property rights—also known as crony capitalism—results in stagnant economic growth, preventing economies from fully developing.
The World Bank defines middle-income economies as those with GDP per capita between 5 percent and 45 percent of US GDP per capita. Examples of countries in this group are Mexico, Indonesia, and Thailand, all of which have shown patterns of growth followed by prolonged stagnation.
Acharya and coauthors Stephen Haber and Alexander Lee argue that many middle-income countries fail to transition to high-income status due to political dynamics that prioritize the stability of the governing regime over economic growth. This often involves favoritism toward a small group of firms while restricting competition. As a result, these economies achieve a second-best outcome: Welfare levels improve compared to low-income economies but fall short of their potential under a competitive system.
An implication of this theory is that addressing political constraints alongside economic factors is crucial for breaking free from this trap. Institutional reforms are essential for transitioning to high-income status, but they require strong political will and robust institutions, which are often stifled in middle-income countries. On a more pragmatic level, the paper presents an important question: Is imperfect development that raises standards of living better than no development at all?
Trade’s impact on Mexico’s job supply and educational outcomes
Returning to a focus on Mexico’s economy, Francisco Cabrera (CIDE) presented the paper “Import Competition and Educational Attainment: Evidence from the China Shock in Mexico,” coauthored with Emmanuel Chavez and Mateo Hoyos. The paper measures the effects of increased Chinese imports on high school dropout rates and labor market outcomes.
Educational attainment is a significant challenge for Mexico, as it ranks lowest in overall educational completion among Organization for Economic Co-operation and Development (OECD) countries. Only 57 percent of Mexicans age 25–34 have completed upper secondary education, compared to the OECD average of 86 percent.
The authors found that regions with a bigger exposure to the China shock—the sizable increase in Chinese imports that many countries experienced in the early 2000s—experienced a 7.5 percent decline in wages on average, particularly in the manufacturing and service sectors. The authors link the increase in imported goods to higher dropout rates, as investing in one's education may not have the same payout as the supply of desirable manufacturing jobs decreases. In addition, declines in manufacturing industries resulted in falling wages for the workers who were able to retain their jobs.
Roundtable on the State of Mexico’s Economy
“Is there a problem with the growth recipe itself or with its implementation?” This question was posed by Alejandrina Salcedo, chief economist of Banco de México—Mexico’s central bank—in response to Mexico’s stagnant economic development.
Her remarks opened a roundtable on the State of Mexico’s Economy. The other panel participants were Miguel Messmacher, former deputy minister of finance and dean of social sciences at the Autonomous Technological Institute of Mexico, and Fausto Hernández, professor of economics at CIDE.
Salcedo presented data on Mexico’s GDP per capita growth and productivity growth and showed how these have underperformed compared to OECD countries, despite a spate of reforms aimed at economic liberalization in the 2010s.
She identified several structural challenges, including weak innovation, lack of competition, insufficient incentives for formalization of economic activity, inadequate infrastructure investment, and weak rule of law.
Messmacher suggested that Mexico’s economic underperformance results in part from a lack of accurate measures for productivity.
He added that the absence of fiscal responses from the government during the pandemic led to significant losses in physical capital as businesses failed to survive.
Hernández pointed to the low productivity of small firms, which account for around 95 percent of all businesses, employ nearly 50 percent of workers, and have informality rates exceeding 80 percent.
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