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Economic Research: For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant


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Economic Research: For Mexico, Nearshoring's Potential Benefits--And Obstacles--Are Significant

Nearshoring has gained attention as supply-chain disruptions during the COVID-19 pandemic made a case for manufacturers to diversify the location of their operations, to minimize production disruptions. Tensions between the U.S. and China, especially around technology, may have also encouraged companies to move some manufacturing production out of China.

Mexico's long-standing manufacturing linkages with, and access to, the U.S. market make it an obvious potential beneficiary for nearshoring. The impact on Mexico's economy could be substantial even if a small fraction of manufacturing production is shifted into the country from other hubs. However, Mexico faces significant challenges to reaping the benefits of nearshoring, including inadequate infrastructure, security concerns, and competition from other countries.

Nearshoring Has Not Decisively Taken Place In Mexico Yet, But There Are Signs It Could In The Coming Years

Trade data does not conclusively indicate that nearshoring is already happening in Mexico. U.S. imports of Mexican goods have been relatively stable over the last decade, at roughly 1.7% of nominal U.S. GDP (see chart 1). Since the pandemic, U.S. imports of Mexican goods increased by about 0.1% of U.S. GDP. However, that was likely owing to higher prices of manufactured goods as a result of the supply-chain disruptions. In fact, total U.S. goods imports grew by over 1% of U.S. GDP since the pandemic, reflecting those price increases.

Chart 1


When focusing on volumes, the data suggests the same--no clear evidence yet of nearshoring. Mexico has not decisively outperformed the rest of the world in manufacturing production, and production in Mexico hasn't improved in recent years (see chart 2).

Chart 2


Aggregate foreign direct investment (FDI) in Mexico also hasn't increased significantly in recent years. While in 2022 FDI, in nominal values, reached its highest level since 2015, at just over $35 billion, as a share of GDP, it has remained around 2.5% in the last years, which is slightly lower than it was before the pandemic (see chart 3).

Chart 3


However, the recent increase in construction of industrial parks and warehouses in the northern part of the country, especially in Nuevo Leon, indicates nearshoring could be starting to unfold in Mexico. Disaggregated FDI data is consistent with that trend. The transportation and storage sector became the second-largest recipient of FDI last year (see chart 4)--it surpassed $5 billion in 2022 and is more than twice what it was before the pandemic. Mexico's economy ministry has also reported a record number of applications from manufacturing companies to start operating in the country, indicating a potential growing interest in shifting some production to Mexico.

Chart 4


The Main Obstacles For Nearshoring Relate To Infrastructure, Security, And Competition From Other Countries

Upgrades to Mexico's infrastructure will be key to increasing manufacturing production substantially. In particular, ports and land-related infrastructure would need capacity improvements, and those projects are typically multiyear endeavors. An inadequate supply of water due to droughts in the northern part of the country--which companies have already reported as an issue--could be a major challenge. Water security for households could also come into play if a greater portion is directed toward industrial use. This issue risks becoming heavily politicized if sufficient supplies are not secured.

Energy supplies face a similar problem--especially regarding availability of clean energy, which is an increasingly important consideration for manufacturing companies' decisions of where to operate. An additional layer of complexity is the centralization of energy generation in Mexico and provision by the government in recent years, leaving less room for the private sector to develop new sources of energy.

Companies operating in the country also face important security-related risks, such as cargo theft and extortion.

Furthermore, nearshoring is a global trend, and companies have options to operate in countries were the risks are lower. Reshoring (producing domestically rather than abroad) is also an important obstacle for nearshoring in Mexico, especially in sectors that are becoming strategically important, such as semiconductors in the case of the U.S. In other words, in some manufacturing sectors, the U.S. could be Mexico's biggest competitor.

How Nearshoring Could Boost Mexico's Real GDP Growth

In a hypothetical scenario in which 1% of China's manufacturing output is gradually shifted to Mexico over the next five years, real GDP growth in Mexico would average 2.6% throughout that period, compared with our 2.0% baseline (see chart 5).

The potential pace and magnitude of nearshoring in Mexico are uncertain. We conducted a hypothetical (and arbitrary) scenario in which 1% of China's manufacturing production is gradually shifted to Mexico over a period of five years. In 2022, 1% of China's manufacturing output was $50 billion, or about 3.7% of Mexico's nominal GDP. Our key assumptions are:

  • Manufacturing output in China grows at the same pace over the next five years as it did in the five years before the pandemic.
  • Deflators for the manufacturing sector equal their pre-pandemic five-year average.
  • The Mexican peso's exchange rate against the U.S. dollar remains stable in real terms.
  • The U.S. reaches full employment, implying that demand for manufactured goods remains strong enough to ensure the shift in production from China to Mexico is not disrupted by weakness in demand throughout the five-year period.
  • The calculation for the impact the nearshoring scenario would have on GDP is based on the implied change in the manufacturing sector's share of GDP.

Under such a scenario, manufacturing real output in Mexico would grow by an average of 5% annually in the next five years, compared with 2% growth in the five years before the pandemic. This would increase the share of the manufacturing sector to about 18.5% by 2027 from 16.6% of GDP in 2022. The manufacturing sector's contribution to real GDP growth, which averaged 30 basis points (bps) before the pandemic, would increase to 90 bps (see chart 6).

Chart 5


Chart 6


When looking at specific sectors that could benefit from nearshoring, the obvious ones in which Mexico has specialized over the last couple of decades are motor vehicles, machinery and equipment, electrical equipment, and computer and electronics. Those sectors combined account for about 7% of Mexico's GDP and already have significant linkages with China (see chart 7). As a result, some of the intermediary production within those sectors that takes place in China could be shifted into Mexico, especially for companies that are seeking geopolitical diversification with access to the U.S. market.

Chart 7


Regional Growth Implications Of Nearshoring

Nearshoring--if it materializes and benefits manufacturing hubs (mostly in the north and center of the country)--would likely increase regional growth disparities. Attracting manufacturing production to the southern part of the country would require significant investment in infrastructure.

The divergence in growth between the south and the north is very large (see chart 8). Median 10-year average annual growth in the south was 0.2%, compared with 3.6% in the states along the northern border. In fact, five of out of the 32 entities (31 states and Mexico City) generate nearly 60% of national GDP growth: Mexico City, State of Mexico, Jalisco, Nuevo Leon, and Guanajuato. Several of those are key manufacturing hubs (State of Mexico, Nuevo Leon, and Guanajuato) that are better positioned to benefit from nearshoring, potentially widening the regional growth disparities.

Chart 8


The government has announced intentions to launch tenders for industrial parks along the Isthmus of Tehuantepec in the south, which plans to connect the Gulf of Mexico with the Pacific Ocean (a potential alternative to the Panama Canal). However, some of the infrastructure-related obstacles are more acute in that part of the country than in the already established manufacturing hubs in the north. Furthermore, companies that want to shift production to Mexico would likely have a strong incentive to operate in well-established supply chains in the north. This means that government incentives to operate instead in the south would have to be very large.

Low Growth Is A Key Negative Factor In The Sovereign Rating On Mexico

We could raise our ratings on Mexico if we believe the government displays effective political and economic management that bolsters the country's subpar growth trajectory, such as with a more dynamic investment outlook. A rating weakness for Mexico is its growth trajectory, which we consider below peers with a similar level of economic development. This was a key reason we lowered our long-term foreign currency sovereign credit rating on Mexico to 'BBB' in 2020. Over the past decade, real GDP growth has averaged 1.5%. Using our 10-year weighted average (forward- and backward-looking) measure of real per capita GDP growth, Mexico's 0.6% estimate in 2023 is below the 2.1% figure for peers with similar per capita GDP.

If growth prospects shift higher consistently, by 0.6% per year to around 2.6%, this could lead us to reconsider our below-average growth assessment. As a result, and absent offsetting negative credit developments, we could raise the ratings--particularly if more robust growth strengthens fiscal dynamics, be it lower deficits, greater budgetary flexibility, or a downward trajectory in debt to GDP.

Nearshoring Could Bring Growth Potential For Companies In Regions With High Industrial Activity

We expect nearshoring to bring growth potential for sectors with sizable operations in industrial areas in Mexico. On one hand, real estate players could further grow their portfolios as demand for industrial space accelerates. Also, e-commerce's increasing share of the retail sector is increasing requirements for large warehouses.

While aggregated housing demand in Mexico has generally declined the last few years, we expect an uptick in housing starts in areas close to industrial facilities. In our view, the country's housing deficit, favorable population demographics, and mortgage financing availability would be supportive of demand trends, despite our expectations for slow economic growth and potentially some minor adjustments to mortgage rates following interest rate hikes from the central bank.

With rising demand for industrial real estate space and housing, we expect improving business conditions for the building materials sector. Specifically for the cement industry, in 2023 we expect domestic production volumes above 45 million tons, with revenue growth in the low- to mid-single digits.

Corporate sectors in Mexico that will receive the more immediate benefits from nearshoring investments will be those that are in export manufacturing activities, such as autos, durable goods, and agricultural products. For industries that are already integrated in cross-border supply chains, nearshoring would help expand sourcing capabilities in Mexico, stimulate improvements to logistics services, and protect the competitive manufacturing cost structure.

The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.

This report does not constitute a rating action.

Lead Economist, Latin America:Elijah Oliveros-Rosen, New York + 1 (212) 438 2228;
Secondary Contacts:Lisa M Schineller, PhD, New York + 1 (212) 438 7352;
Luis Manuel Martinez, Mexico City + 52 55 5081 4462;

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