IN ALMOST every town in Mexico, you will find at least one garish La Michoacana ice-cream parlour, or paleteria. The decor is generally pink, and the ice creams are a rainbow of colours. Flavours include rice pudding, chewing gum and avocado.

La Michoacana is a Mexican business success story, possibly as well known as Dunkin’ Donuts is in the United States. But it is not a corporation, nor a brand, nor a franchise. It is a confetti of independent, family-owned ice-cream parlours. To find its roots, you must travel to Tocumbo, a village in the south-western state of Michoacán, where, when your correspondent visited, the funeral was taking place of two youths beheaded by a drug gang the day before. Small consolation, perhaps, that the locals are so proud of their cemetery they say it is a “joy to die”.

Everything about Tocumbo, from the plush graves to the towering ice-cream monument as you enter the village, speaks to the wealth generated by La Michoacana ice creams since two villagers started peddling them in Mexico City, 500km (300 miles) away, more than 60 years ago. Over the decades, people from Tocumbo have set up ice-cream shops around Mexico (and even in America) and sent money home. Competition from global brands has increased, boosted by the proliferation of convenience stores, but La Michoacana stores mostly remain true to their past. They are the epitome of Mexican small businesses: not only independent and family-owned, but also tatty, with a few people behind the counter, working on and off the books.

They also epitomise Mexico’s stubborn attachment to smallness in business. Tocumbo’s elders have seen off all attempts to organise La Michoacana into something more structured and profitable. The OECD says Mexico has more businesses with ten workers or fewer, as a share of the total, than any other big economy in Latin America: 95.5%, compared with 80-90% in Argentina, Brazil and Chile. Manuel Molano of the Mexican Competitiveness Institute, a think-tank, calls this a “Peter Pan system” in which firms prefer to stay small than to grow, mostly because of tax and regulation. “It’s easier to fly under the radar when you are microscopic,” he says.

Some, like La Michoacana, are small companies that could be bigger. Some try to look smaller than they are: the young men on tricycles in the capital who sell corn tamales from Oaxaca, a southern state, look like freelances, but have a common boss and the same pre-recorded sales pitch across the city.

In recent decades, despite Mexico’s attempts to build export industries like carmaking, such low-wage micro-businesses have been among the few sources of job growth. A study in 2012 by the Inter-American Development Bank showed that between 1998 and 2008 employment in small, informal and “illegal” firms (whose workers get no health or pension benefits) rose much faster than in big, legal firms that add more value to the economy.

This has hurt growth (see chart). Small firms are much less productive than large ones, and only a handful are exporters or integrated into modern supply chains. McKinsey, a consulting firm, says that local bakeries, or panaderias, have only one-fiftieth of the productivity of the largest (such as Bimbo, a thriving multinational). Having almost three-quarters of the workforce employed in such businesses entrenches inequality, because on average they pay much less than large firms, use less-educated staff and are more likely to fail. McKinsey talks of “two Mexicos” moving in opposite directions: a modern, export-oriented one, and a traditional one of small businesses where productivity is plunging by 6.5% a year. Staying small has other benefits, besides facilitating tax avoidance. Little firms can legally pay employees in cash without contributing to the official health-care and pension schemes; it is only when workers are put on salary that such benefits become a legal obligation. Family-run firms also act as an unofficial social safety net. The opportunity costs of staying small are high, however. Small and medium-sized enterprises (SMEs) account for less than 8% of bank loans. That is low, as is lending overall. McKinsey estimates that Mexico’s ratio of loans to GDP matches Ethiopia’s. The Mexican Banks’ Association says that of about 5m SMEs, only 900,000 are sufficiently formal to obtain credit. Those that do pay much higher interest than big firms. Many companies choose to avoid banks altogether: the banks’ association says that more than half of SMEs do not want a loan. Yet few can grow to any size without credit. Even La Michoacana in its early days borrowed money, though its main financier was a villager who lent at extortionate rates, was murdered and is now memorialised by a statue in the main street. Ambitious firms today need more reliable lenders.

Miscellaneous costs

Other costs of the Peter Pan syndrome are a lack of efficiency, technology and innovation. According to Enrique Jacob Rocha, head of the economy ministry’s National Entrepreneur Institute, Mexico’s ubiquitous family-run grocery stores, known as miscelanea, on average keep 28 days’ worth of inventory, compared with five days’ at Oxxo, a fast-growing, modern convenience-store chain. Most lack electronic payment systems and have failed to branch out into the sale of mobile airtime and other billing services that are highly profitable for Oxxo and its peers. Furthermore, firms in the underground economy are prey to extortion by criminal gangs, as well as to fleecing by corrupt municipal authorities.

The government is aware of the problems. Mr Jacob Rocha says one of the main aims of President Enrique Peña Nieto’s constitutional reforms is to weaken the dominance of oligopolies, so that prices of banking services, gas, electricity and the internet fall. That would help small businesses to become more competitive. A fiscal reform aims to bring more of them into the formal economy by giving them a year’s tax holiday. State development banks are providing loan guarantees to promising small firms to allow them to obtain bank credit. Mexico is leading the way among Latin American countries in using e-invoicing as a means of forcing informal businesses out of the shadows (see article).

The government also needs to change some existing policies that encourage firms to stay small and informal. Such businesses reap rewards from subsidies, for example, cheap electricity tariffs. Mr Jacob Rocha hopes to change that: he says that to benefit from government support, small firms will in future have to register with the tax and social-security authorities. They are, however, a huge voting contingent; dismantling their life-support systems would be politically costly.

Some tiddlers have more entrepreneurial zeal, and are not waiting to be prompted by government reforms. Even stubbornly sub-scale Tocumbo has its trailblazers. In the heart of Mexico City, one of the most popular ice-cream sellers is called La Nueva (The New) Michoacana, which draws thousands of customers at weekends. Its boss, Rafael Abarca Fernández, has set up smart booths in shopping malls, and is selling a modern image of healthy products and local enterprise. “We have much higher quality than Häagen-Dazs at a much lower price,” he boasts. Pretty soon, he adds, he hopes to export to Spain.