As the US relationship with China deteriorates across the political, military, economic, and trade dimensions, US companies with manufacturing operations in China are increasingly seeking out strategies to diversify supply chains, mitigate compliance risk, minimize duty exposure, reduce costs, and manage uncertainty. Though several approaches have been pursued since the inception of the US-China trade war, nearshoring is the one now generating the most buzz.
Nearshoring entails relocating or investing in manufacturing capacity close to an end-customer, target market, or corporate hub. European or Asian countries that have benefited from nearshoring include Hungary, the Czech Republic, Portugal, Turkey, Morocco, Vietnam, Malaysia, Thailand, Indonesia, and Sri Lanka. Where the thrust of a company’s business is tied to the North American market, Mexico has been the top choice.
The benefits most commonly mentioned as providing a justification for leaving China to nearshore to Mexico center on managing risk and achieving savings (labor, shipping, etc.). Benefits less frequently noted include the availability of a free trade agreement (the USMCA) and an emerging set of regionally attuned investment/production incentives (the IRA and IIJA, for example), the opportunity to avoid the reputational damage comes with operating in China, and Mexico’s growing internal market.
There is considerable hype, enthusiasm, and curiosity regarding nearshoring to Mexico. Consultancy and chamber of commerce administered surveys consistently report that high numbers of executives are interested in nearshoring (or reshoring). And IGOs (for example, the Inter-American Development Bank) optimistically project that Mexico will, largely on account of nearshoring, achieve record breaking levels of growth over the next five years.
Consistent with the foregoing, Mexico received a record level of FDI in 2022. Significantly, this flow appears to be sustained as year-to-date results for 2023 track those recorded for 2022. Industrial space in Mexico is increasingly difficult to find and it is typically priced at a premium. And, in what is being held up as an indication of what the future holds, Chinese FDI in Mexico has risen 915% between 2011 and 2021. These developments have led some analysts and pundits to opine that the nearshoring dynamic in Mexico has turned an important corner.
Several overarching considerations will determine what becomes of Mexico’s nearshoring moment. These include the still unfolding reglobalization process, distant wars, the specter of new armed conflict, derisking/decoupling practices, supply and demand opportunities associated with different national-level internal markets, and Mexico’s trade, investment, and security policies. Ultimately, the issue can be boiled down to one fundamental question: Is this a flash in the pan that will lose its appeal if/when there is a return to “normalcy” in the trade and investment space or, conversely, is this a phenomenon that can be expected to endure? Though we do not have a crystal ball, historical and current trade/investment practices, considered in conjunction with the significant (and ongoing) deterioration of the US-China relationship, suggests this is the new normal.
Due Diligence Considerations
Notwithstanding the general tendency for companies to focus their nearshoring thinking on labor and logistics, there is a diverse set of considerations to keep in mind when evaluating the possibility of nearshoring to Mexico, including the following:
- Choice of entity and operational model
- Labor costs, skills, and supply
- The strength and nature of MX’s manufacturing base
- Supply chain capacity
- Logistics performance
- Transportation infrastructure
- Cargo security
- Customs clearance practices
- Intellectual Property Rights (IPR) protection
- Environmental regulations
- Non-tariff barriers
- Duty deferral, reduction, and refund regimes
- Exposure to unfair trade and national security actions
- The de minimis shipment environment
- FDI restrictions
- Exchange rate policies
- Dispute resolution
Nearshoring to MX: The Key Questions to Ask
As your company works its way through the nearshoring due diligence considerations noted above, it is crucial you ask (and be able to answer) the following questions:
1. What appetite does your company have for the political, economic, and legal risks that flow from the deterioration of the US-China relationship and the emergence of “Globalization 2.0”? Does your company understand the full scope of risks across the immediate-, intermediate-, and long-terms? Have you adequately mitigated your exposure to trade risk through production diversification?
2. What adverse consequences could arise from leaving China (for example, with respect to your IP, machinery/equipment, inventory, personnel, business reputation, etc.)? Can your company manage any potential blowback triggered by a decision to pursue a “China plus one” strategy? Can your company absorb the costs associated with a total departure from China?
3. Can your product be produced without the involvement of a China-style contract manufacturer? Are you production ready? Are you willing to operate within the framework of a Mexico shelter agreement? Are you willing to operate as a stand-alone permanent establishment?
4. Does Mexico have the skilled labor needed to manufacture your product? If your company were to end up employing Mexican workers, would it have the capacity to deal with the prospect of a unionized workforce and the country’s pro-worker labor tribunals? Will advances in robotics, process automation, AI, 3D printing, etc. render this issue moot?
5. Can the parts, components, sub-assemblies, and/or materials needed to manufacture your product be sourced in Mexico? Or will your Mexico manufacturing operation depend on imported inputs (imported parts, components, and materials make up, per INEGI, 74% of all finished goods produced by Mexico’s maquilas)? If needed inputs can be sourced in Mexico, are they available at a competitive price? If needed inputs are not available in Mexico, can they be sourced from a country with which Mexico has a free trade agreement or otherwise entered under the PROSEC program (in a way that takes advantage of the regla octava), thereby avoiding the USMCA’s lesser of duty rule?
6. Could the operation of certain US laws and regulations (including, for example, the Bureau of Industry and Security’s entity list, the Federal Communications Commission’s authorization bans, the foreign direct product rule, and the Uyghur Forced Labor Prevention Act, etc.) have a chilling effect on the nearshoring of China companies from select industries (telecommunications, electronics) or whose products have ties to the Xinjiang Uyghur Autonomous Region (cotton, silicon, tomatoes, etc.)?
7. Will you have access to the natural resources needed to manufacture your product (water, minerals, etc.)?
9. Will the products you manufacture in Mexico qualify as originating goods for the purpose of receiving preferential treatment under the USMCA? Will your company be able to withstand the scrutiny of a US Customs and Border Protection (CBP) origin verification visit?
10. Will manufacturing in Mexico mitigate exposure to special import tariffs (Section 301), national security tariffs (Section 232), unfair trade remedies (both US AD/CVD and MX AD/CVD), Enforce and Protect Act (EAPA) investigations, circumvention inquiries, and forced labor risk?
12. How does Mexico’s weak capacity for protecting/enforcing IP rights inform your nearshoring thinking (Mexico routinely appears on the USTR’s 301 Watch List)?
14. How important is logistical proximity (transportation costs, lead times, etc.) now port congestion issues are being resolved and freight costs have dropped? Is reducing your company’s carbon footprint an important consideration, especially when considered in light of the facts that CBP is launching a Green Trade Strategy and the US Congress is considering EU-style Carbon Border Adjustment Mechanism (CBAM) legislation?
16. How does the fact that Mexico regularly scores worse than China on both Transparency International’s Corruption Perceptions Index and the administrative efficiency ranking within the World Bank’s Logistics Performance Index bear on your nearshoring thinking?
17. How important is ease/efficiency of communications (language, time zone, etc.)?
18. Does establishing a manufacturing operation in Mexico make sense from the perspective of selling/distributing your product in Mexico, taking into consideration Mexico’s Impuesto al Valor Agregado (VAT), price controls, inflation, lower GDP per capita (compared to China), smaller internal consumer market (compared to China), etc.
19. Does establishing a manufacturing operation in Mexico make sense from the perspective of selling/distributing your product in non-Mexican and non-North American markets – i.e., Asia, Europe, Africa, South America, Africa, etc.?
20. How does the current political and policy environment in Mexico influence your nearshoring thinking?
23. How would the advent of meaningful/enduring legislative relief from Section 301 duties impact your thinking about nearshoring to Mexico? Especially now that it appears judicial relief from Section 301 duties via the US Court of International Trade will not be forthcoming anytime soon?
24. How would US congressional action to either remove China’s Permanent Normal Trade Relations (PNTR) status or make Chinese goods ineligible for de minimis treatment (under Section 321) inform your nearshoring thinking?
25. Do you have the time and resources to carry out a nearshoring strategy?
The bottom line on the issue of nearshoring to Mexico is that it is not a viable strategy for all companies or products. There is no easy, one-size-fits-all answer to the question of whether nearshoring to Mexico makes sense. The answer to this question – as borne out by the factors and considerations discussed above – is a somewhat complicated “it depends.”
The key to coming up with the right answer is due diligence. The set of questions presented in this blog post should be used as an initial checklist to assess the “goodness of fit” between the adoption of a nearshoring to Mexico strategy and your company’s production and distribution reality. Other practical measures companies considering nearshoring to Mexico should be sure to take include:
- Disentangling nearshoring hype from reality.
- Taking a “total cost” perspective (hard/soft, direct/indirect) so as to avoid focusing on cherry-picked factors.
- Adopting an intermediate- to long-term analytical framework when assessing the economic, political, legal, and trade issues that bear on the development and implementation of a nearshoring to Mexico strategy.
- Working with qualified US and Mexico counsel to develop a full understanding of relevant opportunities and challenges.
- Using CBP (including the USMCA Center and the Center of Excellence and Expertise associated with your merchandise) and/or Agencia Nacional de Aduanas de México (ANAM) resources to address any lingering ambiguities or uncertainties (for example, pursuant to the filing of a request for a binding ruling).