The Nearshoring Challenges Mexico Faces

The effects of nearshoring are beginning to be felt in the Mexican economy. During the first half of 2023, a 3.9% YOY increase in exports (totaling US$291.968 billion) led Mexico to reduce its trade deficit by 50.4% YOY. Investments are concentrated in the manufacturing sector, especially in the automotive industry, where FDI reached an all-time high, attracting US$5.024 billion in the first half of 2023, which is the highest figure not only for a similar period, but for any full year. For instance, in January 2023, German automaker BMW announced the construction of an industrial plant in San Luis Potosi, with an investment of US$863 million. In February 2023, Tesla revealed that it was going to invest US$4.5 billion to build a gigafactory in Nuevo Leon, with the goal of producing up to 1 million electric vehicles per year.

Nearshoring could catapult Mexico's economic development; however, the country needs to address significant challenges if it wants to make the most out of this unique opportunity. Mexico's weak rule of law hampers foreign investment, limiting potential job creation as companies grapple with the risk of dealing with disruptions to their operations from criminal activity or facing corruption in governmental procedures.

Many policymakers have raised concerns over the fragility of the rule of law in Mexico, which represents a constant source of uncertainty and risk for companies. According to the National Business Victimization Survey (ENVE) conducted by the National Institute of Geography and Statistics (INEGI), in 2022, 53% of businesses in Mexico considered insecurity and crime to be the most important problems affecting them, amounting to a total cost of MX$120 billion (US$7 billion) (0.7% of GDP). Extortion and theft of merchandise or supplies were the crimes with the highest incidence. These findings are consistent with the latest report of the World Justice Project, in which Mexico ranks No. 115 out of 140 countries in the Rule of Law Index, with a score of 0.42 in 2022, its seventh-consecutive time registering a setback in the index. 

Indeed, the Corruption Perception Index 2022, published by Transparency International, ranked Mexico No. 126 out of 180 countries with the highest levels of corruption in the world, considering, among several factors, bribery schemes and unlawful payments to government officials. This might be why 74% of companies in industrial parks reported drawbacks in terms of ease and speed of procedures in a survey carried out by BBVA Research in 2023 among members of the Mexican Association of Private Industrial Parks (AMPIP).

Moreover, the energy policy of President Andrés Manuel López Obrador (AMLO)  remains an obstacle to the nearshoring trend due to the government’s preferential treatment of the Federal Electricity Commission (CFE) and the bet on oil exploitation for energy self-sufficiency, instead of renewable sources. Similarly, the precariousness of the country’s water and logistics infrastructure are some of the main reasons why it can be difficult for foreign companies to relocate their production lines to Mexico.

Insufficient electricity in Mexico and the demand for green energy to meet environmental commitments are already causing problems for the operation of national and international companies in some states like Guanajuato and Queretaro, slowing the nearshoring boom. The BBVA Research report showed that 91% of companies in industrial parks have experienced drawbacks related to energy supply from clean sources and at competitive prices. 

While AMLO’s administration continues to support oil exploitation through continued financial support to PEMEX and the construction of the Olmeca refinery, international corporations are shifting away from hydrocarbon dependence, focusing instead on developing new sustainable production processes and setting decarbonization goals. According to the Ember Global Electricity Review 2023, only 25.8% of Mexico's energy generation comes from renewable sources, far below other Latin American countries, such as Brazil (89.1%), Colombia (75.5%) and Chile (53%).

In addition, the reform to the Electricity Industry Law promoted by AMLO has been strongly criticized by the US and Canada in the framework of the USMCA, as it prioritizes the dispatch of energy from CFE plants over those of the private sector and raises barriers for obtaining permits and licenses. Over-regulation of the electricity industry has discouraged the entry of foreign capital and continues to be an obstacle to the country's competitiveness.

Another major issue that could inhibit investment appetite is water scarcity, affecting approximately 63% of companies in industrial parks, according to the BBVA Research report. As a result of climate change, which has modified temperature and rainfall patterns, intense droughts have been recorded over the last three years in Mexico. In June, it rained 61% less in relation to the average of the same month from 1991 to 2020 at the national level. Most alarmingly, in August 2023, the National Water Commission reported that the country's main dams are at an average of 44.6% of their capacity. The water crisis has a greater impact on the northern and central states, particularly in Chihuahua, Coahuila, Nuevo Leon, and Guanajuato, which are among the country’s major exporting states, thus being a major concern for incoming companies.

Indeed, Mexico's underdeveloped logistics infrastructure has diminished its level of competitiveness compared to other emerging markets such as Chile, Malaysia, Indonesia, and Thailand. There are concerns that port saturation and poor road quality could result in higher logistics costs. In the World Bank’s Logistics Performance Index 2023, the country ranked 66th, down from 50th in 2010, which points to the need to improve dispatch processes, adopt digital technologies, and encourage environmentally sustainable logistics. Mexico's ranking is slightly below other Latin American countries such as Brazil (51st), Panama (57th) and Chile (61st), and well below ASEAN countries like Malaysia (26th), Thailand (34th) and Vietnam (43rd). Mexico is also the OECD country with the lowest level of investment in inland transport infrastructure as a percentage of GDP, with approximately 0.3% compared to the average of 0.7%. 

Ultimately, if Mexico really wants to take full advantage of the opportunity presented by the nearshoring trend, it must implement urgent measures to strengthen the rule of law and reshape its energy policy to encourage green energy generation and private sector participation. Water scarcity must be addressed from a more comprehensive approach that involves not only a modernization of water infrastructure, but also a rethinking of environmental policy. The Mexican government should also prioritize investment in logistics infrastructure to increase the country's level of competitiveness compared to the rest of Latin America and the ASEAN countries.

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