COVID-19 Trend Booster: Can Mexico replace China?

Even though the US-Mexico relationship can hardly be described as flawless, it has been relatively peaceful compared to a rapidly deteriorating US-Sino relation with China.

With increasingly escalatory tensions between China and the US, Mexico is positioned favourably to attract investments for manufacturing and production activities from its northern neighbour, the United States. Even before economies around the world were hit by the pandemic in early 2020, US companies had begun shifting away from China due to intellectual property disagreements, rising labour costs, political issues and wider resilience concerns. Mexico already started to absorb some of the trade war fallout from the past couple of years, as manufacturing imports to the US reportedly rose by $13bn, while they dropped by $90bn from China in 2019. Thus, COVID-19 has only accelerated what had already been slowly underway. A recent Gartner survey in February/March 2020 found that 33% of supply chain leaders moved business out of China or plan to do so by 2023, with popular alternative destinations being Vietnam, India and Mexico. Another survey by Foley & Lardner LLP’s with 160 executives in the manufacturing, automotive and technology sectors revealed that they intended to move their businesses to Mexico in the next one to five years. Research conducted by Kearney also shows that as early as 2016, US companies had moved production to Mexico specifically to serve the American market.

On August 24, 2020, it was rumoured that Taiwan-based electronics manufacturers Foxxconn and Pegatron, contractor companies manufacturing phones such as iPhones, have started examining the viability of Mexico, as global companies began reassessing their global value chains and calls for near-shoring have been echoing throughout the developed and emerging markets. Foxconn already has five factories in Mexico for the assembly of computers and cell phones, though the likelihood of “Mexico producing […] products with complex supply chains” was assessed to be rather low. However, despite Mexico ramping up its ambitions, many fear Mexican President Obrador’s poor management of the pandemic, meddling in private investment and scrapping of a major airport project will stymie investment interest.

Nevertheless, the potential remains. Part of Mexico’s appeal will be the time zone and proximity it has to the US, resulting in shorter lead times. It takes a shipping container only five days from Mexico to the US, whereas it takes 40 days from Shanghai, creating more risk and less control. In addition to its proximity, Mexico’s other prevailing benefit will be its production costs compared to China. China’s rising middle class has brought along an increase in labour costs, surpassing Mexico’s approximately five years ago. A hypothetical analysis looking at a shifted production from China to Mexico showed that it would save US manufacturers 23% on operating costs; an industrial product Made in China at the cost of $1,000 would decrease by $17 in terms of manufacturing, $18 for logistics operations and a further $182 with the elimination of tariffs, reducing the total cost for a product Made in Mexico to $771. Meanwhile, labour costs compared to the US are just 14% of the total cost for a similarly skilled worker. President Obrador, who “wants to oversee a blue collar boom”, would support such ambitions and it could potentially, if successful, create job opportunities that could also alleviate pressure around immigration issues for the United States.

Mexico comes with great potential and great room for improvement. A trend that first gained major traction with the US-China trade war, causing a great deal of tariff uncertainty and volatility around China, combined with the free trade agreement known as USMCA taking effect in mid-2020, put Mexico in a favourable position. With advancements secured under the preceding NAFTA deal, helping to transform the country into an exporter and manufacturer of trucks, cars, electronics and computers, producing airplane engines and micro semiconductors, Mexico has been dealt a good hand. That is not to say that Mexico is a haven for any business and manufacturing purposes. Issues around safety, raw materials, skilled labour and an existing supply base remain and are factors that take time to build. However, recent developments, such as the trade agreement, consequences of the trade war, as well as the pandemic have moved certain pieces in its favour and can help demonstrate its potential. It is worth keeping in mind that near-shoring alone does not effectively eliminate risk from supply chains, as it would still consist of a single breaking point; nonetheless, Mexico is an appealing market to integrate into a hybrid model (e.g. China+1) through diversification of vendor bases.

Source: Transport Intelligence, August 25, 2020

Author: Dila Cebeci