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The Dartmouth
April 19, 2024 | Latest Issue
The Dartmouth

Kalach: Balancing U.S.-Mexico Trade Amidst Shifting Ties with China

Mexico has a unique growth opportunity by strategically managing its trade relationship with the United States.

As American companies seek to limit their exposure to the pitfalls of making goods in China, some are moving production to Mexico. This shift has bolstered trade between both nations, reaching a remarkable $462 billion in the first half of this year and crowning Mexico as America’s top trading partner. Chinese companies are also investing in Mexico, capitalizing on an extensive North American Free Trade Agreement, now known as the U.S.-Mexico-Canada Agreement (USMCA). Following in the footsteps of Japanese and South Korean firms, Chinese companies are establishing manufacturing facilities in Mexico, enabling them to designate their products as “made in Mexico” before shipping them into the U.S. without import duties.

Mexico faces an intricate path forward, given its dynamic and interdependent economic relationships with both China and the United States. However, ​​if Mexico can effectively navigate the rivalry between these two superpowers, it could substantially advance its economic future.

This interest of American and Chinese manufacturers in Mexico is part of a broader trend known as “nearshoring.” Businesses relocate their operations and/or manufacturing to a country neighboring their consumer market. Mexico has emerged as a leading destination for nearshoring because it is next to the massive U.S. market. As relations between the U.S. and China sour, the United States is increasingly inclined to trade with friendlier partners. Nearshoring is key to this disengagement strategy, as U.S. manufacturing companies relocate their production facilities closer to home to reduce their reliance on Asian manufacturing hubs.

Sure, China offers alluring business opportunities for the U.S., but there are also intricate legal complexities, increased business risks, concerns over intellectual property rights, and the fact that labor costs keep on going up. The worsening diplomatic relationship between the United States and China only exacerbates these factors. The average U.S. tariff on Chinese imports is 19.3%, slightly lower than China's 21.1% tariff on U.S. imports.  In comparison, other WTO member countries with “most-favored-nation” status get a mere 5.9% tariff.

In contrast to China, trade between the United States and Mexico encounters fewer obstacles thanks to the USMCA. The agreement has opened one of the largest free trade regions in the world, generating economic growth and helping raise the standard of living in all three member countries. In the U.S., it translates to over five million jobs that depend on trade with Mexico and over a million dollars in bilateral commerce every minute. 

Mexico maintains intricate and long-standing connections with both the United States and China. On one hand, the U.S. is a dominant partner due to their extensive border, trade ties and a substantial Mexican immigrant population. On the other hand, Mexico’s relationship with China dates back to 1972 and has grown significantly in recent years, with China becoming its second-largest trading partner.

While the U.S. has invested more heavily in Mexico, Chinese investments are increasing, especially in infrastructure and energy projects. More recently, China supplied medical equipment, loans, and over 10 million vaccine doses to Mexico during the pandemic. 

Mexico aims to leverage the USMCA to benefit from this shift and strengthen North American supply chains. However, experts warn that Mexico lacks a clear China strategy. This would require U.S. commitment to investment in Mexico and a collaborative approach instead of one of dominance. Consequently, the decisions made by American politicians and businesses concerning Mexico will unquestionably impact the future of the U.S.-China trade relationship and the economic prospects of all involved.

As the geopolitical landscape continues to evolve, U.S. pressure against trade with China remains a compelling factor. At the same time, the incentives to explore alternative trade opportunities, such as those with Mexico, grow stronger, offering businesses a promising option amid the uncertainties of international commerce.

Countries are increasingly prioritizing supply chain redundancy for critical products such as microchips, energy resources, and rare earth minerals. At the same time, factors like climate change and rising wages in emerging markets are diminishing the allure of shipping low-margin goods like furniture and textiles across the globe, while technological innovations are facilitating rapid and localized manufacturing.

These market dynamics are already underway. A recent McKinsey & Company survey showed 92% of surveyed global supply chain executives shifting towards prioritizing local or regional components, enhancing redundancy and reducing dependence on a single country for essential supplies. As the prevailing economic order continues to shift from globalization to regionalization, it is increasingly evident that nearshoring makes more sense than ever. 

Mexico presents appealing advantages for nearshoring. Beyond its obvious geographical proximity, Mexico has a substantial and cost-effective labor force and robust and advantageous free-trade agreements with both the U.S. and Europe. As American companies pivot towards their southern neighbor to fortify their supply and value chains they are starting to fuel a  manufacturing boom, particularly in the automotive industry, and extending to sectors like data, computing, and home electronics.

According to estimates by Morgan Stanley, this influx of new investments driven by nearshoring could reach approximately $46 billion over the next five years, significantly elevating Mexico's annual GDP growth, to around 3% in 2025-2027, a substantial increase from the estimated 1.9% in 2022. This shift in trade, if taken advantage of, is likely to patch the structural deficiencies of Mexico’s economy, paving the way for creating sustainable jobs, boosting development and stemming migration from one of the poorest regions in the hemisphere.

However, there are obstacles that could impede this growth. Currently, Mexico is not equipped to take on China’s role as the primary provider of a wide variety of products. And although Mexico enjoys favorable conditions in wages, commodity costs, and tax rates, it grapples especially with insufficient skilled labor availability, environmental regulations, infrastructure quality, and intellectual property rights. Energy infrastructure is also a significant bottleneck., requiring an estimated $40 billion investment to support the growth driven by nearshoring. Despite energy infrastructure challenges, Tesla’s $5 billion “Gigafactory Mexico” in Monterrey reflects a significant commitment to the region, but highlights the need to tackle long-term infrastructure needs.

In a world where trade dynamics are in constant flux, particularly in the context of the complex relationship with China, one thing remains clear: the enduring strength of trade between Mexico and the United States. As both countries embrace nearshoring as a strategic imperative, the foundations of this economic partnership appear more robust than ever.

Opinion articles represent the views of their author(s), which are not necessarily those of The Dartmouth.