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Nearshoring Presents Opportunities (and Challenges) for Mexico

While Mexico’s economy stands to gain even if only a fraction of the U.S. manufacturing base heads south of the border, there are significant impediments that could prevent it from reaping any major rewards.

The three key obstacles include inadequate infrastructure, such as supply of water and energy, security-related concerns and competition from other countries, according to a new report from Elijah Oliveros, the lead economist for Latin America at S&P Global Ratings. He and two colleagues co-authored a report that completed a deep dive on Mexico as a possible hub for manufacturing diversification as talk of nearshoring begins to gain greater attention.

“Mexico’s long-standing manufacturing linkages with, and access to, the U.S. market make it an obvious potential beneficiary for nearshoring,” Oliveros wrote in the report.

The report noted that even if 1 percent of total manufacturing in China shifted to Mexico over the next five years, the country’s annual real GDP growth on average could be estimated at 2.6 percent, versus a 2 percent baseline.

Because of recent construction of industrial parks and warehouses in the northern part of Mexico, particularly in Nuevo Leon, “nearshoring could be starting to unfold,” Oliveros wrote. In addition, the growth of e-commerce in the retail sector also has increased the need for large warehouses. He added that transportation and storage was the second-largest recipient of foreign direct investment (FDI) last year, surpassing $5 billion in 2022 and is more than twice what it was pre-Covid.

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“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,” the economist wrote.

But if Mexico wants to increase its manufacturing production substantially, it will need to do major upgrades to the country’s infrastructure. Its main manufacturing hubs are currently only located in the north where there are established supply chains and in the center parts of the country.

Other concerns include ports and land-related infrastructure, which would need capacity improvements—although these are typically multiyear endeavors. But even if these improvements are made, inadequate water supply due to droughts in the northern part of the country and the lack of availability of clean energy could become key issues. Water insecurity already exists for households, and will get worse if there’s any further redirection toward industrial use. Oliveros noted that the “centralization of energy generation” in Mexico leaves less room for private sector development of new sources. In addition, cargo theft and extortion continue to be security-related risks for companies operating in the country.

The economist also said that with nearshoring a global trend, “companies have options to operate in countries were the risks are lower.” That means reshoring—where manufacturing production is done domestically instead of abroad—can become an obstacle for nearshoring in Mexico as companies in neighboring countries try to do more. Moreover, reshoring in some manufacturing sectors could even make the U.S. Mexico’s biggest competitor.

Mexico’s global textiles exports are believed to be in the $7 billion range annually, with the U.S. its largest importer. Key manufacturing specialties—and also major export sectors—that could benefit from nearshoring are motor vehicles, machinery and equipment, electrical equipment and computer and electronics, the S&P report noted. These specialties combined account for 7 percent of Mexico’s GDP and already have “significant linkages with China,” meaning that some of the intermediary production in China could be shifted into Mexico. And where there is already an integrated cross-border supply chain, nearshoring could help benefit sourcing capabilities in Mexico.