The global economic system is transforming, slowly making way for a new model that places greater emphasis on regional blocks. The war in Ukraine and the Covid-19 pandemic laid bare the vulnerabilities of outsourcing and just-in-time supply chains. As a result, companies are looking to pull back their investment in far-away regions and invest closer to home. Nearshoring in Mexico could present the perfect opportunity.
Mexico could stand to gain more from this development than any other country in the world. Its close proximity to the United States and existing trade ties make the country an ideal nearshoring location. Additionally, the potential for lower production, transportation, and labor costs only add to Mexico’s appeal.
In November of 2022, Mexico’s Economy Minister Raquel Buenrostro stated that “more than 400 North American companies have the intention to carry out a relocation process from Asia to Mexico.” Here’s why companies are making the move to nearshore in Mexico, despite the challenges.
The Benefits of Nearshoring in Mexico
All of the world’s major powers, including the United States, the EU, and China are striving for strategic autonomy. They want to be largely self-sufficient when it comes to critical raw materials and energy. They also want to handle their own production of essential goods and technologies. That way, these powers aim to shield themselves from future supply chain disruptions.
In the short-term, this “decoupling” might be problematic for the global economy. But in the long-term, the trend will ultimately increase resilience and reduce the risk of supply chain disruption. And nearshoring in Mexico can help achieve this goal.
Mexico is the 15th largest economy in the world, which is quite surprising given the country’s geographical challenges. Northern Mexico is an arid wasteland where agriculture is only possible by redirecting the region’s few rivers. The South is a dense jungle that restricts the potential for economic development.
One of the country’s geographical benefits is that it enjoys direct port access to both the Atlantic and Pacific oceans. In theory, this would allow Mexico to establish strong trade links with European and Asian markets. However, one of the reasons Mexico has not yet taken full advantage of this opportunity is its prominent mountain ranges. These mountains dissect the country and hinder access from its population centres to its ports.
The country also lacks a navigable river network, which means Mexico relies completely on road and rail to transport goods. Fortunately, its 2000-mile-long border with the world’s largest economy, the United States, saved Mexico from staying a resource-export-oriented economy.
The United States and Mexico
The US-Mexico border region’s cultural, linguistic and economic ties are driven by personal relationships and centuries of history. In some ways, northern Mexico has more in common with the United States than it has with the rest of Mexico.
Because relations between the two countries have been relatively stable and productive over the last three decades, both sides of the border have become deeply integrated. The US-Mexico border is the most-traversed international boundary in the world, with approximately 350 million crossings annually.
In terms of manufacturing, the two countries are joined at the hip. The car industry is a clear example of this, with components crossing the US-Mexico border up to 25 times before final assembly. By some measures, nearly 40% of the value of Mexican manufactured goods sold to the US originally came from the US, but were used in the final production in Mexico. This highlights the sophisticated nature of the commercial relationship between the two countries.
Mexican Regions and Labor Force
Mexico’s northern metro regions of Tijuana, Juarez, Hermosillo, Chihuahua, and Monterrey are thriving. This is because they are connected by less than 300 miles of excellent infrastructure to American cities such as San Diego, Los Angeles, Phoenix, Tucson, Albuquerque, El Paso, San Antonio, Austin, Corpus Christi, and Houston. If the GDP of these cities would be combined together, they would amount to the third-largest economy in the world.
Southern Mexico remains underdeveloped, with an economic growth rate of less than 1%. But the country’s North is quickly growing at 4% per year. Its propensity for trade with the US comes from the simple fact that labour is less expensive in Mexico.
Unlike in the early 2000s, Mexico is now more cost-competitive than China in terms of labour. Mexico’s work force is not only cheap, but also young and even more importantly, it is growing. The median age of Mexicans is 29, which is significantly younger than the median age of 38 in both the United States and China. The country also has a long history of vocational training, and its workforce scores extremely high on technical skills.
Mexico graduates around 125,000 engineers annually, which is not far behind the US’s 150,000. Although Mexico ranks poorly in innovation, these engineers will continue to support the growth of Mexico as a manufacturing base.
Trade Across North America
Economically, Mexico is becoming ever more integrated with the US. In 2018, the North American Free Trade Agreement (NAFTA) was replaced by the United States Mexico Canada Agreement (USMCA). The following year, Mexico became the biggest trading partner of the US, surpassing China and Canada.
It is hard to determine the exact impact of the USMCA due to the effects of the Covid-19 pandemic. However, the trade agreement appears to have been a major success so far. Over the last two years, trade across North America has experienced double digit growth. In September 2022, trade flows reached a record-breaking $3 million a minute.
The USMCA continues to enjoy broad, bipartisan backing in the US. Given the ongoing political support for the trade agreement, the terms are expected to remain stable. Future additions are also likely to further integrate the Mexican economy with the rest of North America.
Nearshoring in Mexico: A Summary
Despite the security and political risks, a growing number of foreign companies are nearshoring in Mexico. Recent investments in Mexico are not just being driven by geopolitical considerations or for the sake of supply chain resiliency. Instead, Mexico’s geographic proximity to the US, well-developed border infrastructure, and cheap but skilled workforce are pulling in business.
Although US-Mexico relations are not without their problems, politicians in both countries continue to promote further economic integration. Going forward, this will provide investors with a sense of long-term stability.
For companies looking to expand or relocate their manufacturing to Mexico, it’s important to understand the country’s risk profile. Especially when it comes to logistics security, Mexico can be a challenging operating environment.
Click here for a more detailed analysis on Mexico’s security landscape.