How Mexico overtook China as the US’s key trading partner

For years, companies in developed countries have been offshoring manufacturing to places where it can be done more cheaply – particularly to China. This is now reversing dramatically. Companies are bringing production nearer to customers. The world is re-plumbing its manufacturing and supply-chain infrastructure, creating threats and opportunities for investors.

The frailty of the just-in-time model of supply-chain management – where manufacturers ordered parts from around the world to arrive almost as they needed them, while running very lean inventories – was exposed by Covid.

Carmakers around the world had to shut down plants, often not because workers had Covid (yet), but because it was virulent in the countries that made many of the parts. Too often container ships were trapped in port without anyone to load or navigate them. With the system’s flaws exposed, companies now want shorter supply lines and more flexibility.

There is also a geopolitical dimension to this phenomenon. War in Ukraine has highlighted vulnerabilities in energy infrastructure to governments. And then there are Sino-US tensions. Encouraged by Joe Biden’s CHIPS and Science Act, the Taiwanese Semiconductor Manufacturing Company (TSMC) is spending $40bn to build two factories in Phoenix, Arizona¹.

The Mexican wave

Manufacturing construction spending in the US has risen 80%² in the past year as other companies open plants there, creating concerns about whether there are enough workers for the jobs being created.

If not opening plants in the US, companies are doing so in neighbouring Mexico. From making air conditioners and cars to Barbie dolls, companies see the advantage of cheap, abundant labour and shorter shipping times.

Daikin, the Japanese maker of air conditioning units, will start production of a new plant in San Luis Potosí in 2024, relocating production away from Asia³. Toymaker Mattel, famous for the Barbie doll, has expanded its factory in Monterrey, Mexico, near the US border⁴. It has closed two plants in Asia, though Barbies are still made in the region⁵.

Tesla has plans to become a neighbour, with a proposed huge flagship investment in a $10bn “Gigafactory” expected to start production as early as 2026⁶.

This activity is having an impact. As of July this year, Mexico has replaced China as the US’s biggest trading partner, with $462bn worth of goods exchanged between the two countries already in 2023⁷. Quite an achievement given China has been well ahead of Mexico for most of the last decade, and a sign of just how much the tide has shifted.

Market share of US imports

Nearshoring is not new thinking. Spanish clothes manufacturer Inditex, owner of fast fashion brands such as Zara, built it into its business model years ago by sourcing a large portion of its clothes from Europe, North Africa and Turkey.

Instead of having to decide on how much and what to sell eight to nine months in advance, nearshoring allows it to make that decision only two months before, which is an inherent advantage in uncertain economic times. Other retailers are trying to follow suit⁸.

More generally, countries globally are looking to boost industry at home. China has a “Made in China” policy; India has a “Make in India” campaign. Indonesia, meanwhile, is banning the export of bauxite – vital in the production of aluminium. By doing so, it hopes to encourage companies to process the materials locally.

The winners...

But what impact does all this have on investors and their strategies? In recent weeks we have begun to build our exposure to nearshoring/reshoring-led growth.

There will obviously be winners and losers, but it is not entirely clear who they will be. At this stage I would argue that it is best to start by identifying the countries that will win.

Mexico is an obvious pick. The country has a young population and wages are cheaper there than across the border in the US. For now, we are investing in the Mexican bank, Grupo Banorte, which should benefit from greater investment and wealth creation in the country.

India is another beneficiary. It has invested heavily in transport and energy infrastructure in the past decade and is continuing to do so. India now has more electrified track as a percentage of its rail network than France or the UK⁹.

Manufacturers used to find excuses for building plants outside India, but today they are much more comfortable investing within. So are overseas companies, attracted by the fact that India is now – since April – the world’s most populous country¹⁰. I recently met with Daifuku, a Japanese automation company we have held in the fund in the past. It is opening another plant in India, like many others, to move production closer to this growing market.

In India, again, we are playing this theme initially through a bank – HDFC Bank. But we are looking for more opportunities and I will be visiting the country soon to meet companies.

... and the losers

China is the most obvious potential loser. It has struggled to recover from Covid and the shifting sands of world manufacturing cannot have helped it. International companies have kept operations there, ‘making in China, for China’, but are no longer as willing to invest for future growth as an export hub.

And it is not an open road for the re-plumbers either, as they face challenges including if there will be enough energy and grid connectivity to support all the additional manufacturing. This problem is particularly acute in Mexico, and, for all the abundance of labour, there is also the question of whether companies can train the workforce quickly enough.

What is very likely though is that we will find more semiconductor engineers in Arizona and production line workers in Monterrey. As capital, people and economic opportunities move, so do we with our investment opportunities.