Distortions in the Mexican Labor Market

Abstract

The variation of real wages in the Mexican labor market has been very large over the last three decades, either measured in dollar terms or adjusted by national price indexes. The overall economic activity has also been subject to three episodes of Depression-sized business cycles. This paper uses aggregate data to measure distortions in the labor market, which can be part of an explanation. The main question is how much of the difference between the marginal product of labor and the marginal rate of substitution between consumption and work can be explained by the distortions we identify. A main conclusion is that the evolution of taxation explains a large part of the variation over time of the measured distortions. Very high tax rates during the early eighties generated high deviations between the marginal product of labor and the marginal rate of substitution, a gap that has decreased since then. A “wage puzzle” arises due to the difference between two measurements of the marginal product of labor: one based upon labor inputs and the other on market wages. The measurement based on real wages shows a huge fall at the beginning of the end of the centralized planning-total protectionism times of the early eighties. However, it seems that the move from generalized regulations on trade and industry and foreign exchange markets towards a freer economic regime was associated with very large changes in relative prices and an adjusted measurement of real wages dissolves the puzzle. Besides taxation, we consider also inflation as a source of the gap between marginal product of labor and the marginal rate of substitution. Inflation has been a very large tax, often reaching levels equivalent to one fifth of total tax collections or more.

Keywords: Mexico, Distortions, Labor Market, Taxes

JEL Classification: E24, J31, O54