Financial shocks increase the need to shift workers among employers, industries and occupations. These disruptions, in turn, can have adverse impacts on productivity.Labor market ; Financial crises ; Developing countries ; Productivity

Erwan Quintin

Sangeeta Pratap

English

Research Papers in Economics

SouthwestEconomy    FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2008 10
Financial shocks increase the 
need to shift workers among   
employers, industries and   
occupations. These disruptions, 
in turn, can have adverse   
impacts on productivity.
Labor Markets in Turbulent Times:
Some Evidence from Mexico
By Sangeeta Pratap and Erwan Quintin
Shock waves from falling housing prices 
and faltering mortgages are making the 
destructive effects of financial turmoil all 
too evident to industrialized nations. In the 
past year, the U.S. and other countries have 
seen billion-dollar write-offs, troubled firms 
and households, and tightening lending 
standards—all of which are taking a toll on 
economic activity.
For Mexico and other emerging econo-
mies, however, financial panics have been 
commonplace. Massive currency devalua-
tions, debt defaults and banking crises have 
crippled Mexico’s economy several times 
during the past 30 years, with prolonged 
and deep consequences. The supply of 
domestic finance slowed to a trickle after 
Mexico’s most recent banking crisis in the 
mid-1990s, and it took more than a decade 
for the financial sector to begin to recover.
Emerging economies are less prepared 
than industrialized ones to weather the im-
pacts of financial turmoil. Such basic institu-
tions as contract enforcement don’t function 
well in the emerging nations, and safety 
nets are generally inadequate. Despite the 
development gaps, emerging nations’ expe-
riences can provide valuable insights into 
the effects of financial difficulties. 
For instance, we can see how abrupt 
disruptions play out in labor markets. Fi-
nancial shocks increase the need to shift 
workers among employers, industries and 
occupations. These disruptions, in turn, 
can have adverse impacts on productivity 
as workers devote time and resources to 
learning new skills and new tasks. This has 
important implications for how financial 
turmoil spreads to economic activity, not 
just in emerging nations but in industrial 
ones as well.
Productivity Plunge
Mexico’s real GDP per capita declined 
sharply as a result of the two major crises 
that hit the country in the past three de-
cades (Chart 1). The 1982 crisis signaled 
the end of two decades of miraculous 
growth. Real output per capita fell by more 
than 6 percent in the year after the crisis, 
Chart 1
Financial Crises Take Toll on Mexico’s Economy
Index, 1994 = 100
70
75
80
85
90
95
100
105
110
115
120
’05 ’00 ’95 ’90 ’85 ’80 ’75 ’70
1982 crisis Tequila Crisis
Real GDP per capita
NOTE: Vertical lines mark the onset of each crisis.
SOURCE: Organization for Economic Cooperation and Development.FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2008 SouthwestEconomy 11
However, several aspects of financial 
crises remain mysterious. For instance, it’s 
now well documented that real GDP falls 
much more than standard measures of ag-
gregate capital use and hours worked.2 
More simply, an economy’s overall pro-
ductivity declines drastically during crises, 
much more than at any other time. 
Economists have offered several ex-
planations for the productivity collapse. 
They’ve argued that the fall of the ratio of 
measured input use to aggregate output 
might result from drops in factor utilization, 
declines in the use of imported intermedi-
ate goods and barriers to the movement of 
resources across sectors.3
We examine another potential expla-
nation—increased labor market mobility. 
Using data from a broad survey of Mexican 
households, we show that financial turmoil 
speeds up worker movement across jobs. 
This acceleration, in turn, likely leads 
to a temporary drop in the effective supply 
of labor as worker displacement makes job-
specific skills and accumulated experience 
less valuable. This, we argue, could account 
for part of the fall of measured productivity 
that typically follows financial collapses.4
The Perfect Storm
Financial crises generate a variety of 
shocks that accelerate resource movements. 
They ripple out from the initial financial 
troubles, amounting to a perfect storm of 
sorts that spreads the damage into the gen-
eral economy. 
First, domestic credit costs rise sharply, 
which saps the profitability of firms that 
rely on outside financing. These companies 
shrink to pay off increased debt or, in some 
cases, shut down. 
Second, the ratio of export prices to 
import prices usually rises, leading over 
time to a reallocation of production toward 
exports and away from goods and services 
for domestic use. This shift is facilitated by 
the fact that export-oriented sectors typi-
cally benefit from a privileged access to 
foreign investment at a time when domestic 
lending is scarce. 
Third, nations in crisis often experience 
deep fiscal shocks as part of the govern-
ment’s effort to boost tax revenues. Tax rate 
hikes have an adverse impact on formal 
employment by giving employers incentives 
to operate outside the tax-paying fold. 
All these shocks are visible in Mexico’s 
Tequila Crisis (Chart 2). The quarterly 
interest rate on dollar-denominated debt 
conditions and fixed exchange rates all con-
tribute to making these nations financially 
vulnerable.1 
Avoiding these pitfalls helps promote 
financial stability. In recent years, improved 
debt management and steadfast commit-
ment to monetary and fiscal discipline and 
flexible exchange rates have helped Mexico 
reduce its exposure to financial shocks.
and ripple effects caused Mexico to expe-
rience a decade of economic stagnation. 
During the 1994–95 Tequila Crisis, GDP per 
capita fell almost 10 percent.
Our understanding of what causes 
financial collapses in emerging economies 
has improved markedly in recent years. 
A heavy reliance on short-term debt de-
nominated in foreign currencies, lax credit 
Chart 2
Shocks Accompany Tequila Crisis
A. Borrowing Costs Shoot Higher
Percent
SOURCE: “Factor Utilization and the Real Impact of Financial Crises,” by Felipe Meza and Erwan Quintin, in B.E. Journal of Macroeconomics, 
vol. 7, no. 1, 2007, article 33.
B. Imports Cost More, Exports Cost Less
Index, 1994 = 100
SOURCES: International Financial Statistics, International Monetary Fund; Banco de México.
C. Government Raises Taxes
Percent
SOURCE: “Factor Utilization and the Real Impact of Financial Crises,” by Felipe Meza and Erwan Quintin, in B.E. Journal of Macroeconomics,  
vol. 7, no. 1, 2007, article 33.
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90
0
1
2
3
4
5
Tequila Crisis
Quarterly interest rates on dollar-denominated bonds
50
60
70
80
90
100
110
120
130
140
150
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90
Tequila Crisis
Real exchange rate
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90
8
10
12
14
16
Tequila Crisis
Consumption tax rateSouthwestEconomy    FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2008 12
soared during the first two quarters of 1995, 
while the real exchange rate collapsed. In 
an effort to reduce budget deficits, Mexico 
increased the consumption tax rate in the 
first quarter of 1995 as well as the regulated 
price of various energy products.
Labor Market Impacts
The shocks that follow from financial 
crises induce worker movements across 
employers, occupations and sectors. As 
Chart 3
Mexico’s Unemployment Rate Spikes
Percent
1
2
3
4
5
6
7
8
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88 ’87
Tequila Crisis
SOURCE: Encuesta Nacional de Empleo Urbano.
Chart 4
Involuntary Separations Rise
(Employer-initiated separations as a share of total separations)
Percent
35
40
45
50
55
60
65
70
75
’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88
Tequila Crisis
SOURCES: Encuesta Nacional de Empleo Urbano; authors’ calculations.
employers in capital-intensive sectors scale 
back their operations, for instance, many 
employees are forced to seek work in sec-
tors less dependent on finance. 
In countries such as Mexico, adjust-
ments are delayed by notoriously stringent 
labor market restrictions. Despite these 
barriers, labor mobility does pick up sig-
nificantly during crises, a fact demonstrated 
by quarterly data from Mexico’s Encuesta 
Nacional de Empleo Urbano, a broad urban 
household survey.  
The survey reveals that the unemploy-
ment rate doubled to more than 7 percent 
as the Tequila Crisis roiled Mexico’s econ-
omy during the first two quarters of 1995 
(Chart 3).  
In addition, involuntary separations 
increased significantly in 1995. The house-
hold survey contains a question that can be 
used to determine whether employees or 
employers initiated recent separations. The 
share of terminations coming from the em-
ployer side rose almost 20 percent during 
the crisis (Chart 4).
Spells of inactivity, whether voluntary 
or involuntary, are only part of the realloca-
tion story, however. Many workers who re-
mained employed during the crisis reported 
significant changes in their employment 
conditions.
For example, the 1995 crisis saw 
marked increases in the fraction of self-
employed workers and those who work for 
establishments with five or fewer employ-
ees (Charts 5A, B). These facts suggest that, 
Shifts across sectors and   
occupations caused by layoffs, 
bankruptcies and downsizing 
are likely to be associated with 
significant declines in   
productivity and real wages.FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2008 SouthwestEconomy 13
ing crisis periods.
The Encuesta Nacional de Empleo Ur-
bano gives us more than 3 million observa-
tions on individual workers between 1988 
and 1999. Looking outside the Tequila Crisis 
period—and controlling for gender, age and 
education—we find that workers who re-
mained in the same sector had real hourly 
wages 1.4 percent higher than those who 
moved.5 During the crisis, the wage gap 
between movers and nonmovers rose to 2.4 
percent for sectors. 
Outside the Tequila Crisis, workers 
among survey respondents, the fraction 
employed in the informal sector increased 
significantly in 1995. 
The informal sector accounts for a 
large portion of production and employ-
ment in Mexico and other emerging econo-
mies. The sector includes all establishments 
and self-employed individuals not comply-
ing with government regulations, such as 
labor laws and the tax code. 
Informal employees typically fail to 
receive government-mandated benefits and 
may earn less than the minimum wage. The 
fraction of workers who fail to receive the 
benefits mandated by labor laws did in fact 
spike up in 1995 (Chart 5C).
Finally, the household survey reveals 
that many of these worker transitions in-
volved occupational and industry changes. 
For example, the fraction of industrial 
workers drops drastically at the onset of the 
crisis, accompanied by increases in workers 
who say they are merchants—a prominent 
occupation among informal workers. 
We use a measure called the Kolmo-
gorov–Smirnov test statistic to compare the 
quarter-to-quarter distributions of employ-
ment for industries at the Mexican classifi-
cation system’s three-digit level. The higher 
the test statistic, the more likely significant 
changes occurred in the distributions. For 
the 1995 crisis, the Kolmogorov–Smirnov 
test statistic shows that certain sectors and 
occupations shrank significantly, making it 
necessary for many workers age 16 to 65 to 
find new employment (Chart 6). 
Wage Impacts
It matters who initiates job changes— 
employees or employers. Shifts across 
sectors and occupations initiated by 
employees—often to pursue higher-paying 
opportunities—are probably going to be as-
sociated with an eventual rise in productiv-
ity and real wages, even if accompanied by 
transitional productivity losses as workers 
adapt to their new jobs. 
Shifts across sectors and occupa-
tions caused by layoffs, bankruptcies and 
downsizing are likely to be associated with 
significant declines in productivity and real 
wages. Workers forced to seek new jobs 
may find their old skills are ill-suited for 
their new jobs, and new skills will have to 
be learned.
We’ve seen that a crisis can trigger 
a marked rise in the portion of involun-
tary labor force movements, making these 
movements a potential explanation for the 
productivity collapses that accompany fi-
nancial disruptions. 
A formal test of our hypothesis in-
volves a comparison of the earnings of 
workers who stay in the same sector or oc-
cupation with the earnings of those whose 
occupational status changes, both in normal 
times and crises. If movers tend to become 
less productive than workers who stay 
put, we would expect them to have lower 
earnings, even after controlling for other 
characteristics that affect earnings. These 
differences should be particularly large dur-
Chart 5
Employment Shifts Accompany Tequila Crisis
A. Employment Status
Percent  Percent
B. Establishment Size
Percent
C. Workers With No Employment Benefits
Percent
SOURCES: Encuesta Nacional de Empleo Urbano; authors’ calculations.
Employees
Employers and own-account workers
Tequila Crisis
20
21
22
23
24
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89
70
71
72
73
74
75
51+ employees
One to five employees
37
39
41
43
45
47
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88 ’87
Tequila Crisis
’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88 ’87
40
42
44
46
48
50
52
Tequila CrisisParagraph Style “TitleHead”
By Author uses the paragraph style
SouthwestEconomy    FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 14
who stayed in the same occupation earned 
about 1 percent more than individuals who 
changed occupations. During the crisis, the 
gap grew to 2.5 percent.
What if workers who change employ-
ment status are systematically different from 
individuals who stay in the same sector or 
occupation? For instance, lower wages for 
movers could reflect differences in inherent 
ability, rather than differences in accumu-
lated skills. 
The fact that each individual appears 
up to five times in the household survey 
enables us to control for these fixed indi-
vidual differences, whether observed or 
unobserved. Doing so reduces the wage 
impact of changing sector or occupation 
during normal times to essentially zero, 
suggesting that labor market flows in and 
of themselves have little effect on average 
labor productivity outside crises periods. 
During the Tequila Crisis, however, the 
wages of individuals who changed occupa-
tions fell by an added 3.3 percent compared 
with the wages of similar workers who 
didn’t move. Individuals who changed sec-
tors saw wages fall about 3 percent more 
than those who stayed in the same sectors. 
Adding it up, real wages fell an ad-
ditional 6 percent during the Tequila Crisis 
for individuals who changed both sector 
Chart 6
Crisis Brings Sharp Changes in Where Employees Work
(Kolmogorov–Smirnov test statistic)
0
10
20
30
40
50
60
70
’99 ’98 ’97 ’96 ’95 ’94 ’93 ’92 ’91 ’90 ’89 ’88
Sector
Occupation
Tequila Crisis
NOTE: Statistic is computed at the three-digit level in the Mexican classifications of occupations and sectors. Due to a classification change, the occupation 
statistics cannot be computed in the second quarter of 1992.
SOURCES: Encuesta Nacional de Empleo Urbano; authors’ calculations. 
and occupation, compared with similar in-
dividuals who stayed put. This constitutes 
evidence that labor market flows cause 
deep drops in worker productivity during 
financial crises.
Mexico’s experience suggests that labor 
market adjustments are an important aspect 
of how financial turmoil ripples through 
economies. The large gaps between emerg-
ing and industrial economies may lead 
to differences in timing, magnitude and 
duration, but both are likely to experience 
significant labor market spillovers from fi-
nancial distress.
The reduced availability of credit may 
result in a pick-up in job destruction, in-
creased worker mobility and temporary 
losses in productivity as workers devote 
time to learning new skills. Whether in 
emerging markets or mature economies, 
these disruptions are reminders of the 
critical importance of maintaining well-
functioning financial markets for economic 
growth.  
Pratap is an associate professor at Hunter College 
and the Graduate Center at the City University of 
New York. Quintin is a senior research economist 
and advisor in the Research Department of the 
Federal Reserve Bank of Dallas.
Notes
1 While the two crises share similarities, they also differ in 
important ways. For more on these issues, see “Mexico’s 
Financial Vulnerability: Then and Now,” by Erwan Quintin 
and José Joaquín López, Federal Reserve Bank of Dallas 
Economic Letter, no. 6, 2006. 
2 See, for instance, “Factor Utilization and the Real Impact of 
Financial Crises,” by Felipe Meza and Erwan Quintin, in B.E. 
Journal of Macroeconomics, vol. 7, no. 1, 2007, article 33, 
www.bepress.com/bejm/vol7/iss1/art33.
3 See, among many other papers, “External Constraints on 
Monetary Policy and the Financial Accelerator,” by Mark 
Gertler, Simon Gilchrist and Fabio Natalucci, NBER Working 
Paper Series, no. 10128, December 2003; “Sudden Stops, 
Sectoral Reallocations and the Real Exchange Rate,” by 
Timothy J. Kehoe and Kim J. Ruhl, University of Texas, 
unpublished paper, 2007; and “Financial Frictions and 
Total Factor Productivity: Accounting for the Real Effects 
of Financial Crises,” by Sangeeta Pratap and Carlos 
Urrutia, Instituto Tecnológico Autónomo de México (ITAM), 
unpublished paper, 2008.
4 This confirms with different data the outcome of some recent 
studies of labor market dynamics in Latin America. See, in 
particular, “Sudden Stops and Reallocation: Evidence from 
Labor Market Flows in Latin America,” by Francisco Gallego 
and Jose Tessada, Massachusetts Institute of Technology, 
unpublished paper, 2008.
5 Details of our estimation approach are available upon 
request. Real hourly earnings are deflated using Mexico’s 
quarterly consumer price index and multiplied by 13/12 for 
workers who receive an aguinaldo, or Christmas bonus. 
Mexican labor laws specify that all employees should receive 
a year-end bonus equivalent to at least two weeks worth of 
earnings in December. In practice, roughly half of workers 
report that they receive an aguinaldo. Among employers that 
do comply with the aguinaldo requirement, the majority make 
the year-end bonus one extra month of earnings.

Labor markets in turbulent times: some evidence from Mexico

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Labor markets in turbulent times: some evidence from Mexico

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