Mexico's government looks to diversify trade partners

Given that Mexico shares a long land border with the largest economy in the world, and that, particularly since the North American Free Trade Agreement (NAFTA) came into force in 1994, barriers to trade and investment between the two countries are minimal, it is natural that the US would be Mexico’s most important economic partner. These linkages are particularly striking in the sphere of exports, with the US accounting for more than 80% of goods and services produced for export in Mexico. The US is also the source of almost 39% of foreign direct investment (FDI) inflows, according to data from the Ministry of Economy.

Economic links are particularly strong between the north-eastern states of Mexico and the border states of the US, which together account for a significant portion of bilateral trade. Much of this cross-border commerce takes place within industries like the auto sector, and even within firms, as corporate decisions have been taken to fragment production so as to maximise the efficiency of US firms’ supply chains.

Exporters from non-NAFTA countries, such as Japan’s Nissan and Toyota, and Germany’s Volkswagen, have also invested in plants in Mexico, as well as cross-border supply chains, with the intention of primarily serving the US market. The election of US President Donald Trump, who campaigned on a platform hostile to NAFTA and based on the perception that US jobs have migrated to Mexico, has given rise to concerns that bilateral economic relations with the US could be on the verge of a major shake-up. This has led, in some quarters, to calls for Mexico to diversify its economic relationships, and particularly the destination of its exports.

More Than Nafta

For Mexico, NAFTA has been transformative, but it is not the only game in town. In fact, Mexico is one of the most open economies in the world, being a member of the World Trade Organisation (WTO) since 1995 and now party to 12 free trade agreements (FTAs) covering 46 countries, including with the EU and the European Free Trade Association, as well as recent bilateral deals with Peru in 2012 and Panama in 2014. Mexico’s participation in negotiations for the Trans-Pacific Partnership (TPP) shows an eagerness to continually reinforce its free trade credentials. While the US has stepped back from the TPP, Mexico has signalled it will explore alternative options to expand its network of trade and investment agreements, and to integrate more closely with Asian economies.

The country has not neglected efforts to strengthen economic links with its neighbours to the south. Together with Chile, Colombia and Peru, Mexico founded the Pacific Alliance in 2011, which saw the creation of a free trade zone with a population of some 217m. Within the zone, tariffs have been eliminated on 92% of products, with the phasing out of the remainder expected in the next few years. In 2011 the country also signed a multilateral FTA with the Central American nations of Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua. More recently, upon his reappointment to government in January 2017 as foreign minister, Luis Videgaray has been tasked by President Enrique Peña Nieto with fostering even closer economic links with Mexico’s Latin American neighbours.

China

The country may find common cause with another target of President Trump’s campaign rhetoric: China. In recent decades the countries have often been competitors as low-cost production locations, particularly after China joined the WTO in 2001. By 2006 China had surpassed Mexico as the second-largest exporter to the US after Canada, and should Mexico’s preferential access to the US market under NAFTA be eroded, China could become even more competitive with Mexico’s auto sector, for example.

Bilateral direct investment has been negligible until recently, and the large increase in bilateral trade has been heavily skewed in China’s favour. Nonetheless, there is scope for increased bilateral economic cooperation, particularly as Mexico seeks investment to develop its infrastructure and exploit its harder-to-reach oil reserves. Ties have been strained on the infrastructure front since the 2014 cancellation of the $3.75bn, high-speed train project linking Mexico City and Querétaro, which was to be developed by a consortium led by the China Railway Construction Corporation. However, in December 2016 Gerardo Ruiz Esparza, minister of communications and transport, announced the project would restart on January 1, 2017, with operations scheduled to start in May 2019.

China’s expertise in infrastructure, combined with its already active presence in the sector across Latin America, suggests this is likely to prove a fruitful relationship. In addition, the China National Offshore Oil Corporation was awarded two of the 10 deepwater blocks on offer during the final phase of the first round of auctions in December 2016 (see Energy chapter).

Diversification Is Key

Mexico’s emergence as an increasingly sophisticated manufacturing hub serving the US market leaves it relatively well placed to export to other markets in a similar manner. The country has developed sectoral specialisations in high-value-added goods such as vehicles, aeronautics and electronics, developing vertical supply chains within the country as domestic suppliers evolved to serve emerging manufacturing clusters. As a result, Mexico has the most diverse and developed manufacturing capacity in Latin America, while still benefitting from relatively low costs of production. Going forward, it will be important for the country to invest in the education and training necessary to ensure its labour force is equipped with the skills required to allow the country to move further up the supply chain and into higher-value-added activities such as product design and development. This will afford Mexico more flexibility in terms of adapting its production to the tastes and demands of diverse markets, while also leaving the country well placed to benefit from maintenance of the status quo, or something very close to it, vis-a-vis the US.

Infrastructure

While Mexico clearly has a broad, open stance on trade and investment, its infrastructure is still largely geared towards producing for export to its northern neighbour. Other than the US, Mexico does not share a land border with any other large markets. Even land access to the smaller Central American economies on its southern border could be hampered by the relatively poorer standard of road infrastructure in the area. Both the location of production centres and the corresponding development of the infrastructure needed for export by land have almost exclusively been oriented towards serving the US. Thus, the development of the country’s port infrastructure in particular would be crucial to underpin an export diversification strategy, whether to serve other markets in Central and South America, or those further afield.

To this end, the location of the new special economic zones in the south of the country, adjacent to port facilities, would seem well judged not only as a means to foster economic growth in underdeveloped regions, but also to support export diversification (see analysis). For the same reason, the ongoing development of Mexico’s most important commercial port in Veracruz has taken on added significance, especially given that cargo volumes through domestic ports increased by 5.5% in 2016, far outpacing its NAFTA counterparts.

Moving Forward

It is still too early to speculate as to the full extent of, or whether there will be, changes in the US policy stance, and whether and to what extent they will seek to alter the terms of NAFTA. Clearly, significant changes could be detrimental to Mexico’s economy, leading to an economic slowdown in the short to medium term, and a need to adapt to a new reality over the longer term. Bilateral trade and investment flows may be reduced, but are likely in any case to remain significant given the sheer size and close proximity of the US to Mexico. By maintaining and expanding open economic relations with a large range of countries, Mexico appears to be adopting a strategy of hoping for the best, but preparing for the worst. Even if the introduction of tariffs or other barriers between Mexico and the US would be far from a best-case scenario, Mexico is still well placed to take advantage of other economic and trade opportunities.