Back in 2018, an unassuming line was added to chapter 99 of the Harmonized Tariff Schedule of the United States, drastically changing the game for over 5,000 products and $200 billion worth of Chinese imports. The amendment added a hefty 25% tariff, marking the beginning of the now infamous US-China economic war.
Global Pandemic
Fast forward to 2021 and the world was gripped by a global pandemic, which dramatically disrupted supply chains. Americans found themselves with extra cash saved from the lock-down and without the usual outlets like restaurants, concerts, and travel to spend their money on, a buying spree on physical products ensued. However, the pandemic was also causing havoc with dock workers and truck drivers in California falling ill, while many of the world's manufacturing hubs in countries like China, Vietnam, and India battled with their own COVID-related issues.
The net effect? A major supply chain crisis. Factories couldn't produce fast enough and ships sat offshore for weeks at a time waiting to be unloaded.
A Brief Respite and a New Disruption
By late 2022, the transpacific capacity crunch had largely dissipated and shipping rates were inching back towards their pre-pandemic levels. But before supply chains could fully recover, a new issue arose: Russia's invasion of Ukraine, which brought fresh havoc to global trade. Key supplies were cut off, energy and food costs skyrocketed, and cargo had to be rerouted.
The Changing Face of China's Economy
At the same time, China's rapid economic growth, largely propelled by low-cost manufacturing, started to slow. Over the past two decades, China's GDP per capita increased tenfold, leading to significant improvements in living conditions and the rise of a robust middle class.
Foreign firms, once attracted to China for its cheap labor, began feeling the pinch as rising wages increased manufacturing costs. Consequently, the peak of inbound foreign direct investment to China passed, as multinationals started seeking out the next lowest cost manufacturing hub.
Despite this, China was far from left in the lurch. The wealth accumulated over the years from foreign investment was funneled into developing an impressive array of home-grown businesses, such as e-commerce platforms JD.com and Alibaba, tech conglomerates like Tencent and Huawei, and even globally successful social media platforms like ByteDance’s TikTok.
The Logistics Challenge: From China to America
In spite of these business advancements, one truth remained: physical products needed to physically travel to reach the American end consumer. And as it turns out, America is really, really far from China. It takes about 18 days for a vessel to reach Los Angeles assuming if everything goes right, which it often does not. Despite improvements post-2021's supply chain chaos, major container carriers only maintain a schedule reliability of 50% - 60%.
With the ongoing geopolitical concerns, including China's potential invasion of Taiwan, the world seems less globalized than it was in 2017. This has sparked widespread concern, with many wondering if we are only seeing the tip of the iceberg when it comes to supply chain vulnerabilities.
What's Next? Building Slack vs. Removing Risk
To mitigate these risks, there are two primary paths forward:
- Fortify the globalized supply chain by building more slack into the system. This could involve ordering components earlier, keeping more inventory in stock, and manufacturing products ahead of time. However, these measures carry their own cost implications.
- Alternatively, remove the physical and political gulf between manufacturer and market. Surprisingly, this option is gaining traction. All that's needed is another developing country with low wages and a large workforce. Enter, Mexico.
The Mexican Mosaic: A Land of Potential Amidst Challenges
From a manufacturing standpoint, Mexico may not immediately seem like an ideal location. It is ranked 128th out of 180 countries on the Corruption Perception Index and 49th out of 190 on the Ease of Doing Business.
The country's terrain - from jagged Sierra Madre ranges run from the country's northwest to its southeast, parched deserts define much of the country’s north, and dense forestry covers much of its south - presents its own set of logistical challenges.
To top it off, none of the world's fifty busiest sea ports are located in Mexico. Its largest, the port of Manzanillo, outpaced nearly six times over by that of Los Angeles and Long Beach.
However, Mexico has one geographic advantage that is impossible to ignore - it shares a border with the world's largest economy, the United States. The World Trade International Bridge, which connects Texas and the Mexican state of Nuevo León, witnesses over 6,000 northbound trucks crossing it every single day. Since its construction in 2000, it has never been busier.
As of 2022, the World Trade International Bridge, a vital inland port straddling the border between Texas and the Mexican state of Nuevo León, emerged as the premier American point of entry in terms of trade value. This surge is largely attributable to the unique attributes that Northern Mexico offers—speed, flexibility, and a low-cost manufacturing environment—something that competitors like China find challenging to match.
The Mexican Pivot: A New Manufacturing Epicenter
Just 150 miles down Mexico's Highway 85, on the outskirts of the small city of Salinas Victoria, lies the Hofusan Industrial Park - a 200-acre complex. It is a product of a strategic private Chinese-Mexican partnership, designed to attract Chinese manufacturers.
The ambitious blueprint involves enticing over a hundred Chinese manufacturers into the gated park. The plan includes the construction of a residential area for employees and a slew of amenities such as Chinese restaurants, hotels, and hospitals. The vision is to recreate a small corner of China in Mexico, offering stable labor conditions and a familiar ambiance for Chinese executives and operators. Six years into the plan, the site is still under construction. However, this hasn't stopped Chinese companies from making the leap. Electronics manufacturer Hisense and furniture makers like Kuka Home, Sunon, and Manwah have already established their presence. They're accompanied by several other Chinese manufacturers like Fawer, Skyish, Lizhong, Asenstar, and Bellinturf, who've all bought into the idea. The trade war between the U.S. and China has only bolstered the case for manufacturing in Mexico. Despite the absence of the planned residential and retail amenities, companies are eager to establish their foothold within and beyond Hofusan Park's gates. Lenovo, for example, has been operating a manufacturing unit just outside of Monterrey for over a decade. 2022 alone saw 44 Asian companies, 9 out of the 10 largest being Chinese-owned, setting up new manufacturing spaces in Mexico, with the majority situating their operations in the state of Nuevo León.
A Balancing Act: Opportunity Amidst Uncertainty
Though challenges regarding security and infrastructure persist, the potential benefits of the move seem too promising for companies to pass up. However, it's crucial to remember that the relocation of a few dozen companies over a decade does not automatically herald Mexico as the new global factory nor does it signal China's abdication of the role. It's also too early to predict the end of offshoring as we know it.
The small but growing trend of companies shifting operations to Mexico reveals a pattern likely to expand due to the fundamental advantages Mexico offers, and this isn't just an Chinese phenomenon. Japan, South Korea, and the U.S. have long recognized Northern Mexico's potential.
Decades before NAFTA, Mexico attempted to capitalize on its lower labor costs and proximity to the U.S. by implementing the Maquiladora system—low-cost, tax-advantaged factories owned by foreign companies. The goal was to attract foreign investment and combat unemployment.
Free trade agreements further amplified the success of these factories. Northern Mexico welcomed auto giants like KIA, Toyota, BMW, Ford, and Audi, subsequently followed by household names like Lego, Samsung, LG, 3M, and GE. A 2012 analysis showed over 5,000 Maquiladoras across Mexico, mostly in the north, employing over 2 million people. This success persists, shifting the perception of Mexican states from dangerous and unpredictable to promising manufacturing hubs.
The irresistible allure of manufacturing in Mexico includes existing infrastructure, competitive wages, strong IP protection, lower political risk, and diminished negative optics of offshoring. Furthermore, being in Mexico eliminates tariff concerns. This combination of factors has drawn a plethora of automotive and electronic manufacturers to Northern Mexico, transforming the local economy and creating a synergistic system that shows no signs of slowing down. China is merely the latest entrant.
The Potential and Challenges of Manufacturing in Mexico
Despite having geography, labor, and demand on its side, Mexico is missing one critical component—a comprehensive industrial strategy. The current administration under President López Obrador has largely neglected this sector, with most efforts to entice and incentivize the manufacturing industry occurring at the state level.
Nuevo León, for instance, has successfully fostered its manufacturing industries by building industrial parks, offering financial incentives, and coordinating with incoming manufacturers. Despite ranking seventh in population, it is third in GDP, trailing only Mexico City and its surrounding state. This has led to Monterrey becoming the country's second-largest wealth center, boasting Latin America's tallest skyscraper and one of North America's most modern metro systems.
However, while Mexico's leadership seems to miss the opportunity at hand, the president's focus on fighting crime is warranted given the country's alarming rise in violence. This has also raised concerns for the U.S., particularly with regard to its impact on immigration.
Improving the economy, therefore, can lead to a reduction in violence and subsequent immigration issues. Most manufacturing in Mexico is replacing Chinese manufacturing rather than American. This transition to a more aligned neighbor is advantageous to the U.S., both globally and in terms of addressing local concerns.
A Future Full of Promise
Even with its issues, Mexico has emerged as a robust, middle-income industrial economy, benefiting from a strategic location and a vast, educated labor pool. It is gradually gaining the economic expansion it deserves—despite ineffective infrastructure, soaring violence, and a somewhat indifferent government.
The current progress is impressive considering these constraints. But one cannot help but envision an even brighter future where Mexico fully harnesses its potential, much like China did four decades ago. With a shift in focus and the right strategies, Mexico could ascend to a global leadership position in the manufacturing sector, offering unprecedented opportunities for the country and its international partners.