Nearshoring is a Near Term Gift for Mexico

“Poor Mexico, so far from God, so close to the United States” is a quote almost every Mexican citizen knows. It’s attributed to Porfirio Diaz, the long-time dictator of Mexico at the end of the 19th and the beginning of the 20th century. He said it in a rueful way, and throughout Mexico’s tumultuous history, proximity to the US has proved at times problematic. However, in the context of the 21st century, that proximity may no longer be a burden; in fact, it may be a blessing. Already at the turn of the century, Mexico was brought into the North American Free Trade Agreement, which created one of the largest free trade zones in the world, covering over 500 million people and accounting for US$26 trillion in GDP. This inclusion spurred trade and investment in Mexico and made it the third-largest trading partner of the US. As the world becomes ever more complex and the struggle between China and the US intensifies, Mexico could again become a beneficiary of its geography. US politicians and business leaders are now grappling with overexposure to China and nearshoring to Mexico may provide the answer that everyone is looking for. 

If the war in Ukraine has taught Western leaders anything it’s that a single point of failure risk is not an option. Europe in general was severely over-reliant on a single source for its energy needs, that being Russia, and has had to pay the price, quite literally, for not having a diversity of supply when it comes to hydrocarbons or other energy sources adequate to meet demand.  The reality of the situation is that Europe got addicted to cheap energy and it was willing to take the risk to maintain the status quo. While the embargo of Russian hydrocarbons to Europe has caused disruptions in energy markets globally, the effects are relatively limited to that space. Russia was never a major holder of European sovereign debt or a manufacturer nation exporting products to the world. It was a raw commodity exporter with very little else to offer to global markets. China is the opposite of Russia in that sense. In the same way Europe fell for cheap energy from Russia, the world  fell for cheap production of goods from China. If a similar scenario were to unfold between China and Taiwan, and a subsequent embargo were to occur, the entire globe would find itself in a supply chain crunch that might be irreparable. Thus, Western leaders are looking at how to mitigate this single point of failure risk. 

The Energy Transition as we know it today, from solar panels to electric vehicles, is heavily dependent on Chinese processing and manufacturing from a supply chain perspective. Chinese domination of the polysilicon market, one of the key components of  solar PV panels, is near total. Ten years ago, China represented just 30% of global polysilicon production. Two years ago, Chinese production had risen to 76%, and for the solar-grade sector 80%. With massive expansion efforts underway in China today the country could come to control 90% or more of global polysilicon production in the next few years. Lithium, an essential input of any li-ion battery, is another market China has sought to corner. China controlled 65% of the world’s lithium processing and refining capacity in 2021, and in that same year, controlled 79% of lithium-ion battery manufacturing capacity. The COVID-19 pandemic exposed the latent fragility of the global supply chain, especially as it relates to China. As the country went on strict lockdown, its plants and transport systems also shut down. Western leaders are now imagining this same scenario but on a much bigger and long-term scale and the idea of bringing that production capacity closer to home is making more and more sense.

Nearshoring is defined by the Oxford Dictionary as “the practice of transferring a business operation to a nearby country, especially in preference to a more distant one.” There is a lot that is left out of that, however, and looking holistically at the concept it’s really a risk-mitigation strategy writ large. The lessons of COVID and the war in Ukraine have made it abundantly clear to US policymakers and businesses that depending on China isn’t in the long-term strategic interest. Mexico has both the necessary and sufficient conditions to replace large parts of that global supply chain that is held in Chinese hands. Those conditions are proximity to the US and relatively cheap labor. Mexico and the US share a 1,951-mile border, and also have existing interconnected road infrastructure. Average labor costs are now cheaper in Mexico than in China. Add to this the fact that Mexico, the US and Canada are already part of a free-trade agreement, now known as the USMCA in the US or T-MEC in Mexico, and the combination seems just right. While US auto manufacturers have long been in Mexico, companies like Tesla are also getting in on the act and not just on the assembly side. Already the Mexican government is thinking of setting up a lithium-ion battery industrial park where many different battery manufacturers could establish themselves and serve the wider auto-manufacturing industry in Mexico and the US If the nearshoring phenomenon comes to full fruition, Mexico could see a 30% increase in exports in the next several years. The Inter-American Development Bank found in their own study that through nearshoring Mexico could add US$35.3 billion to its annual export value. 

These are significant numbers by anyone’s measure and Mexico is uniquely positioned to benefit from the current nearshoring trends. Above-ground risk is always a metric companies and other governments will consider when deciding where the best location for nearshoring might be. It’s incumbent on Mexico and its politicians to be mindful of that fact. The issues swirling around the USMCA and the energy sector in general in Mexico today might give some pause. There is always the worry of jumping “out of the Chinese frying pan and into the Mexican fire;” however, when considered over a longer period, and multiple different administrations, the inherent advantages that Mexico possesses over any other nearshoring destination for the US are unassailable. The fact of the matter is that the relationship between Mexico and the USs will only deepen and become more intertwined as time moves forward.