Why Are US Companies Manufacturing in Mexico?
September 9, 2019
The American economy is currently in the midst of a boom the likes of which hasn’t been seen since World War II. In early July, the U.S. broke records by hitting 121 months of growth, the longest economic expansion in the history of the country. Despite the fact that we have massive GDP growth and sit at a near full employment level, American manufacturing has experienced its weakest growth in a decade, much in part due to the fact that a manufacturing exodus has been taking place.
Now, your first thought may be that American companies are picking up shop and setting down in China, but you’d be wrong. They’re heading south of the border to Mexico where a manufacturing renaissance has transformed their economy. Currently, its economy is 15th in the world with analysts projecting that it’ll reach 7th by the year 2050. But why are American companies now doing business in Mexico instead of east Asia? In short, the answer is complicated. Below, our Mexico manufacturing specialists will delve into the factors that are moving manufacturing to Mexico.
Why Are US Companies Manufacturing in Mexico?
There are surprisingly many benefits of manufacturing in Mexico for American companies. For years, American lawmakers and economists have sought ways to strengthen the bilateral economic relationship with our southern neighbor. The proximity between the countries, economic connections, and cultural ties have forged a bond that surpasses borders. Their efforts have been largely successful. Since 2010, American trade with Mexico has grown by a factor of at least 30% every single year. Now, U.S.-Mexican trade represents a half trillion dollars, with Mexican manufactured goods accounting for 14% of the American import market.
There are several reasons why American companies are relocating manufacturing facilities to Mexico. For the sake of simplicity and overview, it’s much easier to understand American manufacturers’ motivation for relocation by focusing on one of three categories:
- Recent trade policies
- Changes in the Chinese market
- Mexican manufacturing advantages
Most economists will agree that NAFTA was largely responsible for U.S. manufacturing becoming competitive on a global scale while also helping Mexico develop into a competitive modern economy. This radical free trade agreement aimed to make it simpler for America, Canada, and Mexico to trade by eliminating tariffs and lifting other trade barriers. According to James McBride:
The hope was that freer trade would bring stronger and steadier economic growth to Mexico, providing new jobs and opportunities for its growing workforce and discouraging illegal migration from Mexico. For the United States and Canada, Mexico was seen both as a promising new market for exports and as a lower cost investment location that could enhance the competitiveness of U.S. and Canadian companies.
The deal reshaped North American economic relations by creating integrated supply chains amongst the countries, especially between the U.S. and Mexico. Economies of scale dictated that manufacturing work occur wherever it’s the cheapest and most efficient. And so, Mexico became a vital producer in key goods such as:
- Automobiles and auto parts
- Aeronautics parts
- Medical devices
On November 1st, 2006, the Mexican Federal Government published a decree to promote the Manufacturing, Maquila and Export Service Industry (IMMEX Decree). The goal of this was to:
- Increase competitiveness of the export sector
- Lower logistics and administrative costs
- Streamline procedures
- Increase oversight capacity
- Create certainty and transparency
The underlying drive of these actions was to stimulate foreign investment in Mexican manufacturing. According to the Secretaría De Economía the primary mechanism for this was that, “It provides holders the opportunity to temporarily import, free of import tax and VAT, the goods necessary for use in an industrial process or service to produce, transform or repair foreign goods temporarily imported for subsequent export or the provision of export services.”
According to Mexico, goods that can be imported duty-free include:
- Raw materials, parts and components which are to be totally integrated into export goods; fuels, lubricants and other materials for consumption during the production process of export goods; containers and packaging; labeling and leaflets.
- Shipping containers and boxes.
- Machinery, equipment, tools, instruments, molds and spare parts for the production process; equipment and devices for contamination control, research or training, industrial security, telecommunications and computing, laboratory, measurement, product testing and quality control; and those involved in handling materials directly related to export goods and others linked to the production process; administrative development equipment.
This encouraged the first large wave of American companies to abandon doing their manufacturing business in the states or in China in favor of Mexico. American companies began to use maquiladoras in Mexico or a shelter company to manufacture in Mexico. In the space of a decade, Mexican manufacturing increased by 60 billion dollars per year.
In 2018, President Trump successfully renegotiated NAFTA under the new name U.S., Mexico, Canada Agreement (USMCA). Although the deal has not yet been fully ratified and installed, Mexican analysts see this as a boon for the country, especially for the manufacturing industry. They forecast that certain new stipulations will not only cause American manufacturers to leave the U.S. but to abandon China as well.
The clause with the most important impact on Mexican manufacturing is known as the Rule of Origin. It states that 75% of a car or truck’s parts must be made in NA, which is a 12.5% hike from the previous level under NAFTA. Since most of Mexico’s automotive industry was already in compliance with the new levels, many American manufacturers will be forced to relocate out of China and into Mexico.
The Fluctuating Chinese Manufacturing Market
For decades, China was the place for U.S. manufacturers, much in part due to its cost-savings benefits. The cost of doing business there was inexpensive largely as a result of China’s extremely low labor costs and the relatively low cost of oil. Now, though, a shift is occurring, and manufacturers are fleeing China for Mexico in droves.
Reasons for this include:
- Increased labor wages – In 2013, China started requiring that its companies give employees a 13% average annual minimum wage increase. Analysts expect that the Chinese wage advantage to be inconsequential by the year 2021.
- Transportation costs – In the 90s, when an oil barrel cost a third of what it does today, transportation costs were worth the long haul. Now, though, as oil prices are higher and continue to be volatile, manufacturers are more wary of relying upon this relatively unpredictable factor in order to do business.
- Proximity – In addition to the sheer difficulty of transportation logistics, the further American companies are away from their factories, the harder it becomes to efficiently manage and provide oversight. To make matters worse, the 15-hour time difference between the American west coast and China cause coordination and communication to be an exceedingly challenging affair.
- Tariffs – While President Trump may be harsh on Mexico, China has felt the wrath of his tariffs on a much larger scale. Tariffs on China have had a noticeable impact on the cost of doing business there. According to the South China Morning Post:
The US had earlier threatened to impose new tariffs on US$300 billion of Chinese goods that were not yet subject to additional duties. However, July was also the second full month in which the higher 25 per cent tariff rate was applied to US$200 billion of Chinese exports to the US. The US raised the tariff from 10 per cent on May 10, meaning there is now a 25 per cent tariff on US$250 billion on Chinese exports, tariffs that were not in effect at the time of Xi and Trump’s ceasefire deal. Recent economic figures have been almost universally poor.
- Currency Fluctuation – Chinese currency fluctuations have become increasingly volatile over the past decade. This instability makes it difficult for companies to accurately forecast cost and project revenue.
Advantages of Manufacturing in Mexico
For decades, American manufacturers gradually shifted production to Mexico; but now it’s happening at a record-setting pace. What has gotten economists in Mexico really excited though, is the fact that it’s no longer solely U.S. companies making the move. Rather, multinational companies from all over the globe are seeking to invest in this rapidly emerging marketplace and take advantage of Mexico’s changing landscape in Manufacturing.
In addition to all of the factors driving Mexican manufacturing, Mexico provides American manufacturers with some key cost-savings advantages that can’t be mimicked elsewhere. These include:
- An educated workforce – Compared to Asian options, Mexico’s labor force easily exceeds theirs in terms of educated workers. These days, Mexico would be able to compete on an education and skills basis with practically any developed country on earth. In fact, Mexico specializes in producing engineers at a rate that far surpasses those coming from the states.Because manufacturing has been an emphasis of the economy, Mexico now has two, if not three, generations of workers with manufacturing experience, which can greatly ease operations and management.
- A cheap workforce – Although USMCA has allowed for Mexican manufacturing workers to unionize and fight for better wages, over the last decade, Mexican wages have remained stagnant at approximately $2.20 per hour for factories in Mexico. China surpassed that figure in 2010 and now have doubled the Mexican hourly wage. Although the hourly wage has increased, China’s level of productivity has increasingly slowed down. In contrast, the productivity in Mexico has increased while labor costs have seen a decline. Over recent years, we have seen the wages in Latin America are now lower than those in China.
- IMMEX drives down the cost business – The ability to temporarily import raw materials and manufacturing costs duty free has made manufacturing in Mexico an enticing option. The cost savings on duty alone have been enough to encourage many American companies to make the switch. On top of this, to continually attract foreign investment, companies that do their manufacturing business in Mexico get various fiscal perks such as a special income tax.
- Ease of transportation – Especially compared to China, the logistics of transporting goods made in Mexico into the states is a much easier task. In the last decade, Mexico has invested heavily in rail and highway infrastructure to further stimulate foreign investment. In addition, the proximity between the U.S. and Mexico shortens the supply chain and reduces delivery times and fuel costs.
- Proximity – For companies that need rapid turnaround times, or quick and reliable deliveries, manufacturing in Mexico removes much of the logistical nightmare you’d have when operating overseas. Also, its nearness makes it easier to make adjustments, visit facilities, and manage operations.
- Fortune 500 industries – Mexico is already the proud home of various industrial giants, in particular, the major industries in Mexico are those within the aerospace, automobile, and electronic space. In just the automobile industry alone, Mexico hosts:
Also, BMW, Audi, and Daimler are in the process of building new assembly plants in Mexico. Analysts expect that automotive manufacturing will be the largest industry within the country, making it one of the foremost automobile exporters in the world.
Moving to Mexico
Over the last decade, the Mexican government has made concerted efforts to stimulate foreign investment and drive manufacturing business into the country. This strategic move has been largely successful, particularly thanks to fortuitous occurrences in the Chinese market. These days, if you want an easier and more affordable option for your manufacturing, it’s time to start looking south of the border.
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