Mexico is in a prime spot for multinationals looking to move operations closer to their main markets. But the expected wave of nearshoring firms is yet to materialise due to rising costs, creaking infrastructure and political uncertainty, and so is the promised economic boom.
The notion of nearshoring came to the fore during the pandemic. As the healthcare emergency brought East-West supply chains to a near-standstill, CEOs started talking about investing in manufacturing sites closer to their customers. The pandemic-era disruptions compounded companies’ concerns over global trade that had been sparked by the United States’ imposition of sanctions against China in 2018. More recently, Russia’s invasion of Ukraine in 2022 and growing tensions between Washington and Beijing have made near-shoring even more of a priority in boardrooms around the world.
Eric Martel, CEO of jet-maker Bombardier (BBDb.TO), talked up the benefits of nearshoring in 2022 when he announced plans to expand the company’s manufacturing capacity in Mexico. Meanwhile, Citi (C.N) CEO Jane Fraser said last November that the corporate world was reaching “a tipping point” in the reversal of decades-old efforts by companies to reduce costs by sourcing and moving manufactured goods as cheaply as possible.
On the face of it, Mexico has many of the ingredients international companies are looking for. To start, it shares a land border with the United States and benefits from the tariff exemptions granted by the United States-Mexico-Canada Agreement (USMCA) – the free trade zone it established in 2020 with the United States and Canada. It’s also accessible by sea from both Europe and Asia. Those routes are less vulnerable to the geopolitical issues and climate-related disasters that are currently haunting two other key trade corridors, Egypt’s Suez Canal and the Panama Canal.
Over the past few years, Mexico has certainly become more central to global trade. U.S. imports from Mexico totaled $455 billion in 2022, up nearly 19% from the previous year and up 64% from 2012. At the same time, the share of Mexico’s imports from China went from 1% in 1994 to 20% in 2022 according to a recent study by academics Laura Alfaro and Davin Chor - a sign of Beijing’s desire to bypass trade tensions.
If that continues, the economic benefits of nearshoring could transform Mexico. A flurry of new manufacturing plants could add an additional 3% to the country’s GDP over the next five years as well as over 1 million jobs, according to a recent study by Deloitte. President Andres Manuel Lopez Obrador has tried to ride the nearshoring wave. Last October, for example, he announced that international electric vehicle manufacturers could claim an 86% tax deduction on investments in the country. With such generous breaks on offer in other industries too, more companies may be tempted to join Tesla (TSLA.O), Unilever (ULVR.L), Bombardier and Dell Technologies (DELL.N) in announcing plans to set up in Mexico. Ironically, Chinese companies are also arriving in droves - including construction equipment maker Lingong Heavy Machinery and Tesla rival BYD (002594.SZ).
But Mexico is not reaping the benefits yet. Although foreign direct investment has remained steady at around 3% of GDP for much of the last decade, only a minority of Mexican-based companies report seeing an increase in demand for their products due to near-shoring, Deloitte found.
That’s concerning because Mexico’s perceived advantages are fading fast. The scramble for industrial space is driving up costs which were already rising. According to the Mexican Chamber of the Construction Industry, the price of cement and reinforced steel surged by up to 25% since the end of 2021 to mid-2022. Meanwhile, land prices are ballooning. In Santa Catarina in the northeastern state of Nuevo Leon, the cost of land has increased by 25% since Tesla announced it will be building a factory there in March 2023. It’s also more expensive to employ staff. In January, the minimum wage increased 20% to nearly $22 for the free zone near the northern border and $14.50 for the rest of the country. That is double what U.S. companies are required to pay their workers. And the surge in the Mexican peso, which was the best-performing currency in the world last year, according to Trading View, is also driving up local costs. The danger for the Mexican government is that these factors could soon start to deter companies.
Mexico’s creaking infrastructure is also a problem. Last October shipping giant Hapag Lloyd (HLAG.DE) warned customers about delays in the key Mexican port of Lazaro Cardenas, which had already suffered three months of delays. The mounting challenges make it harder for Mexico to compete with rivals. That’s a problem given the country has yet to experience a sizeable economic windfall despite all the near-shoring talk. For example, manufacturing as a percentage of GDP only increased to 21% in the first half of last year, a tiny bump from pre-pandemic levels of 20%. Mexican drug cartels also pose a security risk to workforces and ramp up insurance costs.
Meanwhile, companies have been quick to announce plans for new manufacturing but are much slower to take action. Tesla has yet to begin construction on its Nuevo Leon factory. Last October Elon Musk said he was not ready to go “full tilt” on Mexico as he is worried about high interest rates and the health of the global economy. Four other companies have also announced plans but have yet to establish new manufacturing sites in Mexico, according to a well-placed source.
Other near-shoring destinations face similar challenges. Vietnam, Canada, Germany and India are all expected to experience dramatic surges in manufacturing thanks to companies reconfiguring their supply chains. That may take some time to materialise. Companies like to talk about “de-risking” their supply chains to reassure shareholders but are often slow to break ground on new plants because of cost and logistical issues.
And if Donald Trump wins the U.S. presidential election in November, he might take action against foreign imports. He recently vowed to slap a 100% import tariff on Chinese cars made in Mexico if he moves back to the White House.
To be sure, things could also change for the better, at least in Mexico. Despite the tax breaks, the left-wing administration of López Obrador is not universally loved by business. The election in June could yield a more business friendly candidate. Claudia Sheinbaum, who is running with Obrador’s support as he cannot seek re-election, is the current front-runner from the ruling Movimiento Regeneración Nacional (MORENA). She is expected to be more pragmatic about tapping private capital once in power than her mentor.
But unless Mexico can assure international companies it’s a reliable partner, its near-shoring boom will die out at sea.
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CONTEXT NEWS
The Mexican government expects nearshoring - the trend of locating manufacturing capacity closer to the US market rather than in Asia - to add up to 1.2 percentage points to GDP growth, which is expected to reach 3.5% in 2023.
In the first six months of 2023, Mexico received around $29 billion in foreign direct investment, up 5.6% from the same period in 2022. More than half of that was in the industrial sector.
