Growing tensions between the US and China have prompted manufacturers to seek more secure supply chains closer to home. Mexico has emerged as a major beneficiary, boosting both exports to the US and imports from China, but do the numbers really add up? Isaac Hanson reports.

Since 2019, the US and China have been locked in a trade war, with tariffs, legal threats and sanctions hampering business between the two countries. As a result, US goods imports from China fell 20% between 2022 and 2023.

To protect their supply chains, US companies are increasingly turning to trading partners in more geopolitically aligned countries.

Mexico, in particular, stands out as an attractive alternative to Chinese supply, with lower average incomes (US$8,100 annually in Mexico compared to US$13,800 in China, according to Trading Economics), and a long history of trade ties with the US.

In 2023, the combination of declining trade with China coupled with a 5% annual increase in US imports from its southern neighbour meant Mexico overtook China as the top exporter to the US for the first time in decades.

Throughout the 21st century, approximately 80% of Mexico’s exports have been destined for the US. The bond between the two nations was solidified with the signing of the North American Free Trade Agreement (Nafta) in 1994, tying the southern state’s economic future to its northern neighbour.

The 2020 renewal of this agreement as the United States-Mexico-Canada Agreement (USMCA) has only strengthened the connection, deepening trade ties between the two countries.

China, meanwhile, has faced escalating tariffs and political hostility throughout the Donald Trump and Joe Biden presidencies as part of a wider US effort to protect its global economic dominance and reduce reliance on a key geopolitical rival.

This has contributed to a rise in nearshoring and friendshoring, strategies aimed at securing supply chains against geopolitical risks.

Nearshoring refers to moving production to countries closer to the target market, while friendshoring involves relocating production to politically aligned nations.

In Mexico, these two strategies are closely intertwined.

“US and EU restrictions imposed on China – including in the financial, trade, service and defence industrial sectors – give Mexico a clear business advantage over China,” Verisk Maplecroft senior Americas analyst Arantza Alonso tells GTR.

“Mexico’s stable trading relationships with the US and the EU have proven attractive to businesses looking to mitigate the operational and reputational risks cascading from US-China geopolitical tensions.”

 

The appeal of Mexico

Since the USMCA came into effect, Mexico’s exports to the US have surged by 30%, reaching US$434bn in 2023. US foreign direct investment (FDI) into the country has also risen, climbing from US$9.8bn in 2020 to US$13.8bn in 2023, although levels have fluctuated over the past decade.

According to the Office of the United States Trade Representative, the manufacturing sector is the leading target of this funding.

This is something Mexico is keen to encourage; in October 2023, its government issued a decree offering tax incentives to boost investment in export-focused sectors specifically “in response to the growing trend of nearshoring worldwide”.

Most of this investment is directed towards the development of Mexico’s maquilas: factories located along the US-Mexico border that operate as mini special economic zones. These facilities are able to import raw materials and goods without tariffs or duties, provided that they are predominantly used to produce goods for export.

Maquilas are governed by Mexico’s Maquiladora, Manufacturing and Export Services Industry Program (Immex), which in 2016 accounted for 85% of the country’s manufactured exports.

The automotive sector is one of the major beneficiaries of foreign investment and interest in Mexico. Electric vehicle manufacturer Tesla announced in 2023 that it intends to build a US$4.5bn production facility in the northern state of Nuevo León. Whilst this project is currently on pause until after the US election, other automakers, including Audi and BMW, have revealed plans to expand their operations in the country to meet rising demand for electric vehicles.

BMW is currently constructing an €800mn battery assembly facility in its San Luis Potosi factory, and Audi plans to invest €1bn into its Puebla factory to manufacture a new electric car. Both plans operate under the Immex programme.

 

What about China?

But it is not only the US that has been drawn to Mexico’s export-friendly environment; Chinese businesses, in particular, have found it an attractive market for investment. Since 2020, China’s FDI in Mexico has increased more than it did throughout the whole of the 2010s, although the US’ investment remains far higher. There is also evidence to suggest that Mexico is being used as a layover for Chinese goods en route to the US to avoid US-China tariffs.

“Much of the Chinese investment pouring into Mexico represents a rerouting of trade from China through Mexico to the US,” Elizabeth Stevens, managing director at Geopolitical Risk Advisory, tells GTR.

According to the Mexican Secretariat for the Economy, over 50% of China’s exports to Mexico over the past year have been machinery, which includes parts, circuitry and generators. If these products are then finished in Mexico and exported to the US and Canada, they can “bypass trade tariffs as there is no USMCA duty or China Section 301 tariff”, Stevens says.

Chinese exports to Mexico have risen by 1.5% since Donald Trump took office in 2017, according to an April report by Moody’s Analytics, although it is difficult to assess the extent to which these goods or components end up in the US market.

At the same time, Mexico’s manufacturing exports to the US grew 1.7%, but Mexican factories used 3% less of their total capacity.

The Moody’s report concludes that this “leave[s] the door open to the possibility that the increase in the volume of manufacturing production, without utilizing more capacity, could be partly explained by products generated outside of Mexico”.

 

The limits of friendshoring

In terms of US imports, Mexico’s gain is not necessarily China’s loss, however. For US companies, supply chain realignment is a slow process, and China remains a major source of goods that Mexico currently cannot supply.

“Friendshoring should not be overstated,” says Stevens.

“It takes years to transition supply chains to new suppliers. Bilateral imports of goods and services from China to the US reached their peak in 2022 at US$564bn. This occurred due to an increase in sales of products that are exempt from tariffs.”

China and Mexico also serve different segments of the US market.

GTR analysis of US Bureau of Economic Analysis data shows that 98% of the increase in Mexican goods exports to the US from 2022 to 2023 came from the automotive sector. Despite China’s large auto production, it exports nearly nine times less to the US than Mexico.

Where China mainly lost out was in the consumer goods sector, with exports to the US falling 21% during the same period. This was indicative of a larger trend; total US imports of consumer goods fell 9.7% in this period. Mexico’s exports in the sector also fell, though by a negligible amount.

Research by supply chain management company Flexport also cautions against viewing 2023 as a definitive year for identifying longer-term trends.

“When supply chains started normalising [post-Covid] and consumption growth slowed, inventories accumulated,” wrote then-Flexport researcher Christopher Clague last year. “What we’re seeing now in US consumer goods imports is a correction of that overshoot, not some portent of the end of globalisation.”

One challenge Mexico faces in positioning itself as a friendshoring hub is that it lacks critical minerals and technological goods the US needs, and that only China can supply.

“China still exports significant volumes of strategic products that Mexico cannot source, such as rare earth minerals, PV cells and computers,” Alonso at Verisk Maplecroft says. “This means that the US is still dependent on China to cover certain needs.”

While it is difficult to gauge the full impact of the US-China trade war on Mexican exports, the tensions show little sign of slowing, no matter who wins the White House in November. The longer it drags on, the more opportunities Mexico will have to leverage its business-friendly environment and geographic proximity to step into any gaps left by the Asian giant.