The last infectious wave peaked in January 2022 and vaccination is progressing. Looking ahead, the recovery will continue (Table 1). Exports will continue to benefit from strong growth in the United States. With a larger share of the population vaccinated and the gradual improvement in the labour market, consumption will also be a key growth driver. Investment will also pick up, driven by planned infrastructure projects. Inflation will edge down, after the significant increase in 2021. The latest fiscal plan foresees that the deficit will remain broadly unchanged in 2022 and gradually decrease thereafter. As such, the fiscal stance, while remaining cautious, has become less restrictive and provides mild support to the recovery.

Mexico’s potential to be a high-growth economy is large. It has transitioned from being an oil-dependent economy in the early 1990s towards a manufacturing hub, highly integrated in global value chains, today. The proximity to the United States export market is a fundamental competitive advantage. However, such potential remains unrealised and growth over the last decades has been low (Figure 2).

Medium-term growth prospects have weakened. Informality, low competition, financial exclusion and corruption are some of the factors hindering productivity growth. Weak investment and low female participation rates deteriorate growth prospects further. The updated trade agreement in North America can give fresh impetus to growth. However, a comprehensive reform agenda is needed to reboot investment and turn around productivity.

Mexico has been fiscally prudent over the years, broadly meeting its fiscal targets and ensuring fiscal sustainability despite having the lowest tax-to-GDP ratio in the OECD. Revenues have been resilient during the pandemic and the fiscal deficit widened only slightly.

Social spending and public investment have recently increased, but the pandemic has created additional needs, as poverty has risen, health and education systems are strained, and infrastructure gaps remain. Accompanying spending increases in these essential areas with a gradual increase in tax revenues would help to respond to these spending needs while maintaining and reinforcing Mexico’s commitment to debt sustainability.

Broadening tax bases, by eliminating inefficient and regressive exemptions, holds the promise of increasing revenues without increasing tax rates. There is also significant room to strengthen subnational taxes, namely property and vehicle taxes.

Investment, muted since 2015 and falling since 2019 (Figure 3), is hindered by uncertainty about domestic policy settings. Uncertainty particularly increased following proposals to reform the electricity market. With the appropriate policy settings, the potential for investment to restart is high. Mexico could reap further benefits from the strong recovery in the United States and the on-going reorganisation of global supply chains closer to consumer markets. Of particular importance are reforms to provide certainty about existing contracts and regulatory stability.

At around 55%, informality remains high and is both a cause and a consequence of low productivity. A comprehensive strategy is needed to reduce informality, with actions needed in several policy areas. Improving business regulations at state and municipal, which in some instances remain costly and complex, should be a key building block of that strategy.

Reforming trade regulations would also bring benefits to consumers and strengthen productivity. Mexico is well integrated into manufacturing value chains, but there is room for further integration in services. Continuing to reinforce the anticorruption framework and strengthening implementation of already enacted legislation is also fundamental to boost productivity and improve governance.

There is significant room to improve access to finance by firms and households (Figure 4), which would boost growth and inclusion. Fostering competition in the banking sector would contribute to reduce interest rate margins, supporting SMEs access to credit. Fintech’s potential to strengthen financial inclusion could be realised by upgrading digital payment regulations.

Mexico was a pioneer among emerging economies in taking action on climate change mitigation and adaptation. However, additional policy action is needed to meet emission targets. Mexico’s potential in the renewables sector is high but remains untapped. The electricity market reform under discussion proposes to establish a guaranteed market share of at least 54% for the public electricity company and to eliminate regulatory bodies overseeing competition and granting permits. Mexico is also increasing investment in fossil fuel exploration and extraction and building a new refinery. Transport is the second largest emitter sector. Experiences of several Mexican states attest the benefits of transitioning towards cleaner transportation means.

Mexico has one of the highest levels of poverty and income inequality in the OECD, which calls for continuing efforts to strengthen social protection, reduce gender gaps and improve education.

The pandemic and the associated increase in social vulnerability signal the need to continue strengthening the social protection system and making it more efficient and responsive to economic cycles. The number of recipients of social programmes has recently increased. Reducing fragmentation and improving targeting would offer the possibility of extending coverage further, particularly among low-income households.

Important reforms to labour market regulations and pensions are underway. Reforms to enhance conflict resolution, workers representation and collective bargaining hold the promise of facilitating labour disputes resolution and compliance with workers’ rights. The reform of the pension system, agreed with the private sector, addresses some of its weakness, such as low benefits and limited coverage.

Mexico has made good progress in improving female political representation but labour force participation lags the OECD average and other Latin American countries (Figure 5). Care responsibilities fall disproportionally on women, hampering their prospects to complete education or be in the labour force. Reducing gender inequalities would boost growth and well-being significantly. Women have been particularly hit by the pandemic, as they were particularly affected by long schools closures and were more predominantly employed in sectors requiring in-person work.

The education system was highly impacted by the pandemic. After one of the longest schools closure in the OECD, pre-existing inequalities are likely to widen further. Before the pandemic hit, best performing students had a similar level of performance as the OECD average. However, the gap between top and bottom students in Mexico was large and equivalent to four years of schooling.