Financial frictions and productivity: Evidence from Mexico

Mexico exhibits a level of financial development much lower than other Latin American and upper middle income countries. I quantify the aggregate total factor productivity (TFP) losses from resource misallocation arising from financial frictions in Mexico, using a standard model of credit-constrained entrepreneurs with heterogeneous productivities, and detailed, publicly available, data on the entire universe of Mexican establishments. The implied TFP losses are 10%, which represent 23% of the observed TFP gap between Mexico and the United States. The results suggest that the standard model captures well the role of bank credit in allocating capital across small and medium sized firms, but potentially misses the role of equity markets in financing investments by the largest firms.