Rapid diversification of Mexico's export markets unlikely in one-year outlook even if US leaves NAFTA

Mexico's Minister of Economy Ildefonso Guajardo (left), Canada's Minister of Foreign Affairs Chrystia Freeland (centre), and US Trade Representative Robert Lighthizer address the press at the closing of the NAFTA meetings in Montreal, Quebec, on 29 January 2018.

Peter Mccabe/Contributor/AFP/Getty Images: 911847798

The country's existent free trade agreements (FTAs) have already liberalised trade with a total of 46 countries and besides Canada and the United States – the other members of the North American Free Trade Agreement (NAFTA) – they allow Mexico to export its products tariff free to, among others, Chile, the European Union, Israel, Japan, Norway, Peru, and Switzerland. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) will be signed by Mexico and 10 additional countries (Australia, Brunei, Canada, Chile, Japan, Malaysia, New Zealand, Peru, Singapore, and Vietnam) in Chile on 8 March 2018. In the context of the ongoing NAFTA renegotiation, the country's adherence to CPTPP is significant as it will lay the foundations for Mexico to develop and expand trade relations with the Asia-Pacific region. However, despite the CPTPP's potential economic and trade-related importance, the agreement (even if ratified by its members) is unlikely to drastically/rapidly lead to a major diversification of Mexico's export markets.

Multiple FTAs but dependency on the US largely unchanged

Export market diversification, even if the US decides to leave NAFTA prompting Mexican firms to look for alternative markets, will not happen overnight. As the chart below highlights, 89% of Mexico's total exports were bound to the US in 2000, and it took the country eight years to lower such dependency on the US as its main export market to 80% (still a large number) in 2008 (the chart represents the latest available data covering Mexican annual exports since 1993 for the January–November period). Such diversification was gradual rather than immediate, and it only started to accelerate after five years (from 2005 onwards) from the country's FTA with the EU coming into force. This highlights how despite Mexico's multiple FTAs the incentives for a major diversification of its export markets were likely to have been slowed down by the benefits of lower transportation costs and highly integrated supply chains historically built with the US.

The competitive advantage of exporting to a major market located across the border remains to date and has not prevented US-bound Mexican exports from growing despite the ongoing NAFTA's renegotiation or the protectionism threat coming from the US (unilateral tariffs imposed by the Donald Trump administration). Mexican US-bound exports increased 8.4% during January–November 2017 compared with the same period of 2016 to USD298.9 billion. Although Mexico has continued signing FTAs since 2008, the country's exports to the US (for example, vehicles, electrical machinery, machinery, optical and medical instruments, agricultural products) have not drastically changed, averaging 79.8% of total exports based on January–November data. However, although exports to the US are growing, uncertainty over NAFTA's renegotiation has had a negative effect over the past year on the Mexican peso (making exports more competitive), and some companies have put investment decisions on hold until there is more clarity regarding the outcome of ongoing NAFTA renegotiation.

Slow export market diversification

Despite having FTAs with 46 countries across the world, and not counting the US, there is no trade partner in the world importing more than 3% of Mexico's total exports (see chart below based on annual January–November data). The largest beneficiary of Mexico's FTAs outside NAFTA has been Germany, but this country only imported 1.71% of Mexico's total exports in January–November 2017. Canada, a major partner under NAFTA, imported 2.78% of Mexico's total exports during the same period and China, which hinted in June 2017 that it would consider a FTA with Mexico, imported just 1.62% of Mexico's total exports, also during January–November 2017.

Outlook and implications

Mexico's Minister of Economy Ildefonso Guajardo said on 30 January that CPTPP would act as a cushion in the event the US decides to withdraw from NAFTA. However, as highlighted by the above points, Mexico will likely struggle rapidly (in less than two years) diversifying its export markets to counter any negative effects connected to a potential US withdrawal from NAFTA. Existent FTAs will certainly help and together with an additional 31 bilateral investment treaties the country will have the option of exploring other export markets. However, Mexican businesses would likely need the support of the Mexican government and economic and trade promotion state-run agencies such as ProMéxico to help Mexican businesses build new business relationships and particularly to compete, integrate supply chains, and understand previously unexplored markets. The undertaking of such a task will take time, increasing the probability of the country's economic growth slowing down during the first years of a hypothetical US NAFTA withdrawal involving higher tariffs for Mexican products exported to the US. IHS Markit is forecasting a 1.8% GDP growth in 2018 based on the renewed uncertainty over NAFTA, tax reform in the US, and a gloomier outlook for the construction and hydrocarbons sectors.

Nonetheless, the sixth round of the NAFTA renegotiations ended on 29 January on a positive note, with all parties agreeing on updates to the treaty's anti-corruption and information technology-related issues. There were also advancements on sanitary and phytosanitary measures, telecommunications, and technical barriers to trade, although no progress was with the most contentious issues (those related to rules of origin, inclusion of a sunset clause, reforming the treaty's dispute settlement mechanism, and improved labour standards in Mexico). The next round of renegotiations has been scheduled for 26 February–6 March in Mexico City, and the probability of any agreement being postpone until after the US mid-term Senatorial elections in November is growing. Key indicators to watch related to a positive outcome of the ongoing NAFTA renegotiations include: 1) US President Donald Trump toning down his rhetoric to reduce the US trade deficit with Mexico as an indicator that political interference in the negotiations is starting to decrease, increasing the chances of an agreement. 2) Mexico dispatching its ministers of economy and foreign relations abroad, accompanied by Mexican businesspersons, in an effort to boost trade with the Asia-Pacific region, China, and the EU as an indicator of the country starting to implement a strategy designed to counter a potential US NAFTA withdrawal.