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Is Mexico Nearshoring Its Way to Prosperity?

Jan 08, 2024

Domestic American politics and U.S.-China relations have both soured in the last several years. China and the United States were once robust trading partners, but protectionist economic policy from both sides has set off several unintended consequences. Indeed, American political leaders have continually warned that China would “eat our lunch” and have consistently placed obstacles in the way of free trade, creating today’s protectionist nightmare. 

Scrutinizing American policy– U.S. restrictions on trade and investments with China, carried out under both the Trump and Biden administrations, has led to the drop in Chinese imports from 20 percent to about 14.6 percent of all U.S. imports. The pandemic and supply chain issues have contributed to the decline, but tariffs have accelerated the trend as, for example, the average U.S. tariff on Chinese imports – about 19 percent – is more than six times 2018 levels. 

This drop has led to a repositioning of U.S. trade partners around the world. Mexico, in fact, has taken a slight lead accounting for 15 percent of U.S. imports, with China in second place with its 14.6 percent, and Canada in third place accounting for 13 percent of all U.S. imports. 

More importantly, with the emphasis on its lower tariff access to the U.S. market, there has also been a significant shift in trade and investment towards Mexico. The signal to international investors is to take advantage of building factories and warehouses in Mexico to get their products into the U.S. market under more favorable terms. The trend by some manufacturers, known as “nearshoring,” where companies move their manufacturing plants closer in order to access the U.S. market, has led to greater economic activity. In Mexico, for instance, local industry vacancy rates are around five percent nationwide and zero along the border with Tijuana. 

Lower costs for land, labor and other factors of production, have Chinese and other investors “nearshoring” or reconfiguring their manufacturing capacities by steadily moving them to Mexico. Tesla, for example, has similarly moved some of its automotive manufacturing to Mexico in the last few years. The bottom line for Mexico is an increase of over 40 percent in foreign direct investment (FDI). 

While China currently accounts for only one percent of Mexico’s FDI, one report by the Federal Reserve of Dallas indicates China is expanding investment and is now the fastest growing source of foreign investment in Mexico. 

One significant barometer of increasing FDI is the growing demand by international investors buying the Mexican peso to pay for investments. The result is a surge in the rise of what is being called the “superpeso.” There has been a 15 percent increase in the peso’s value versus the U.S. dollar from June 2022 to June 2023. As of this writing, the peso is at a high exchange rate of 17.2 pesos to 1 US dollar. The weakened dollar has also seen a significant shift in some Latin American markets towards holding pesos. Mexico already accounts for 25 percent of FDI in Latin America and the Caribbean and the new shift could boost those numbers. 

Additionally, a stronger peso will have a number of mixed consequences for Mexico. In the long run it will make Mexican exports more expensive, working against an otherwise long-time competitive advantage. Another consequence involves the fact that a strong peso will lower the value of remittances from the U.S. to Mexico. Conversely, growing investments in Mexico may make Mexico more of a magnet for the growing number of Central American migrants who would otherwise traverse through Mexico on their way to the U.S. border. A robust Mexican economy could slow the flow of migrants into the U.S., but only if other conditions are improved south of the Rio Grande. 

Conditions in Mexico, however, will have to improve before a sustainable economic development environment is created. And improving conditions in Mexico will only be viable if Mexican policymakers can adopt better policies that lead to long-term solutions, including continuing to crack down on corruption in both the public and private sectors to safeguard investments– a tall order. Drug trafficking and violence from drug cartels continues to threaten investments and the country’s overall economic development. 

Mexico’s next presidential election will be historic as a woman will be elected to govern the country. The ruling MORENA party of President Andrés Manuel López Obrador has nominated Claudia Sheinbaum, former head of government for Mexico City. While a coalition of the former ruling PRI, PAN and PRD parties have nominated Senator Xóchitl Gálvez of the PAN. This unprecedent historical event will likely coincide with a shifting economic panorama which, if handled correctly, could mean an era of greater prosperity for Mexico. 

The continuation of a MORENA government will likely mean greater emphasis on state intervention and redistributionist policies that may well inhibit the development of productive forces going forward. The placement of greater economic resources in the hands of the central government bode poorly for a decline in corruption and corruptive practices. 

With the opposition’s election, there are possibilities for allowing both domestic and foreign investment to lead the drive towards greater productivity and improved job growth with a result which will work to spread wealth without substantially hindering further growth. 

Either outcome will most likely continue to promote “nearshoring,” having a positive effect for supply chains around the world and taking advantage of competitive advantages in an international division of labor. The real question is whether this opportunity will be seized by Mexico’s decision makers to promote full employment, rising real wages and a higher standard of living. Of course, economics tells us hard choices will have to be made, but as Thomas Sowell reminds us, “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”

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