Reshoring from China to Mexico – How Prevalent is it Really?

The cheap labor that propelled China from economic stagnation to the precipice of a high-income country in 2021 may soon be no more. The rapid economic growth over the past couple of decades has – happily – led to a steady increase in wages and improved living standards. However, this has placed increasing pressure on manufacturers who have for a long time relied on the low operational costs in China, leading some to consider relocating operations to other countries.

The concept of “reshoring” took off in China after the instigation of the China-US trade war in 2018, when tariffs on billions of dollars’ worth of Chinese goods led some investors to reconsider the viability of China as a destination for manufacturing and other operations.

More recently, stringent COVID-19 control measures imposed in China at a time when most other countries are opening up has reignited discussion of reshoring, as companies struggle to keep production going and are reconsidering their future in the country.

Some analysts have argued that one of the best options for companies operating in the North and South American markets looking to diversify their supply chains is reshoring to Mexico, pointing to its lower operational costs and proximity to the U.S.

In this article, we discuss how prevalent the phenomenon of reshoring out of China is and whether Mexico has significant advantages over China by looking at key metrics, such as operating costs, market size, trade, and diplomatic relations.

Foreign investment in Mexico vs China

There are no concrete numbers on the number of companies that have relocated factories or production facilities from China to Mexico, and incidents of this occurring therefore at most amount to anecdotal evidence.

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Research from Management Consulting Firm Kearney shows that the trend of reshoring from 14 “typically low cost” Asian countries to the US actually slowed in 2020 and 2021, following an acceleration in 2018 and 2019 in the wake of the US-China trade war. However, given the recent COVID-19 developments and global geopolitical conflicts that have broken out since this research was conducted, it is possible that this trend will once again reverse in 2022.

The U.S. has continued to invest in both China and Mexico. The U.S. is the biggest investor in Mexico, accounting for over 45 percent of FDI inflows in 2021. In 2020, the investment amounted to US$10.24 billion, down from US$12.85 billion in the previous year, likely due to the impact of the pandemic.

FDI into China from the U.S. also decreased in 2020, from US$2.69 billion to US$ 2.30 billion in 2020. Statistics from China’s Ministry of Commerce, however, show that in the first four months of 2022, the FDI from the U.S. into China grew 53.2 percent.

Attractiveness of China vs Mexico for foreign companies

China at a glance

Despite the ongoing COVID-19 pandemic and geopolitical tensions, China has proven itself to be an attractive and reliable investment destination.

In 2021, China’s GDP grew by 8.1 percent to reach RMB 114.4 trillion (US$17.7 trillion). With this growth, China’s economy surpassed that of all 27 European Union countries combined, which stood at US$15.73 trillion.

Already the world’s second largest economy, it also does not appear to be stopping anytime soon. With a population of 1.4 billion, China’s GDP per capita was US$12,551 in 2021, about six times lower than that of the U.S. While it is not guaranteed that China’s per capita GDP will reach parity with the US, the gap shows that there is still significant room for economic activity and household wealth to continue to grow before leveling off at a saturation point.

China has also accumulated other advantages to back up its leading position in the global market and maintain investor confidence. These include its huge market growth potential, its skilled labor pool, unparalleled infrastructure, and constantly improving capabilities as a manufacturing base for industries of the future.

Mexico at a glance

According to the World Bank, Mexico is the second-largest economy in Latin America. In 2021, its GDP reached US$1.29 trillion, a growth rate of 4.8 percent.

Mexico has a large diverse economy and is currently the US’ second largest trading partner, accounting for 14.5 percent of total trade in the first quarter of 2022.

Top US product exports include electronics, vehicles, fuels, minerals, plastics, and machinery. In addition, Mexico is the second-largest agricultural export market for the US and imported US$19.5 billion worth of US agricultural products in 2018.

Mexico is also a member of the World Trade Organization (WTO) and has 13 free trade agreements (FTAs) that cover 50 countries, including the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the United States-Mexico-Canada Agreement (USMCA). Due to these FTAs, Mexico’s market is one of the most competitive and open in the world.

The advantage of investing in Mexico is that Mexican companies and suppliers are familiar with US.. products and services. U.S. businesses typically find it straightforward to market their products in Mexico. Promising industries for U.S. businesses in Mexico are agriculture, auto parts and services, aerospace, education services, energy, environment technology, information technology, transport infrastructure, and tourism, among others.

Diplomatic relations, trade agreements, and tariffs

Mexico benefits from significantly better bilateral relations with the U.S. than China does. Although not without its issues, the relationship has improved significantly since US.. President Joe Biden took office in January 2021, which prompted the reinstatement of several modes of dialogue and cooperation channels that were abandoned during the previous administration, such as the North American Leaders Summit (NALS).

The China-US relationship, however, has not recovered even after the Biden Administration took over the White House. Despite hopes to the contrary, Biden did not lift tariffs on Chinese goods imposed under the Trump administration. In addition, rising tensions as a result of the Russia-Ukraine conflict raises concerns that China could inadvertently be hit with sanctions as it continues to engage with Russia.

Some foreign companies in China have signaled that the political tensions between China and the U.S., in particular in the wake of the Russia-Ukraine conflict, have become a growing consideration for exiting the China market, as businesses risk being caught in the crosshairs. According to a recent flash survey from the European Chamber of Commerce, seven percent of companies have already considered ending current or planned projects due to the risks associated with the geopolitical tensions between the EU and China. It is, therefore, possible that some companies may view Mexico as a lower-risk option for operations.

However, there is currently little hard evidence to show that companies have followed through on these concerns when weighing the risks against the benefits of continuing operations in China, of which there are still many, as we discuss below.

Tariffs

The U.S. has imposed tariffs on around US$300 billion worth of Chinese goods for import. These products have been divided into four different lists with the first three lists approved in 2018 and the last list approved in 2019. Tariff rates are as high as 25 percent on some imported items. According to PIIE, average US tariffs on Chinese exports remain elevated at 19.3 percent, more than six times higher than the pre-trade war tariff. These tariffs cover 66.4 percent of US imports from China.

In contrast, there are almost no import tariffs on Mexican goods to the U.S., as stipulated under the USMCA. Goods that are still subject to import tariffs can enjoy a reduced rate, meaning these goods are still cheaper to import from Mexico than many other countries.

It’s nonetheless important to point out that the U.S. has indicated it may lift tariffs on some Chinese goods over the summer in an effort to combat runaway inflation. According to a notice published on the website of the Office of the US Trade Representative (USTR) on May 3, 2022, the U.S. may lift tariffs on some Chinese goods as part of a standard legal requirement for the USTR to review tariff actions four years after they were instated. The four-year anniversary of two tariff actions, which took effect on July 6, 2018 and August 23, 2018, under President Trump, will occur this summer.

The notice called on representatives of domestic industries that benefit from trade tariffs on Chinese goods to submit requests for the continuation of the tariffs during two dockets open from May 7 to July 5 and July 6 to August 22, respectively. If a request is submitted to the USTR, it will commence a review of the tariff to assess whether it will be extended. If no request is submitted for a given tariff, then it will presumably be lifted, but no official statement has been made on the timeline or certainty of this happening.

Cost of operations

Currently, the average industrial power rate in China is around US$0.084/kWh – somewhere in the middle when compared to the rest of the world. The average industrial power rate in Mexico range from US$0.09/kWh to US$0.11/kWh, slightly higher than that of China.

While it’s hard to get specific statistics, other utility rates, such as gas and industrial lease rates in Mexico, are considered substantially lower than that of China.

One potential draw for companies to reshore to Mexico is the lower cost of operations in the country. China’s success in growing its economy over the past few decades has resulted in rising wages over the past decade. Average minimum wages in China, which vary from region to region, are now higher than in Mexico.

Data from Statista also shows that hourly wage for manufacturing workers has been consistently higher in China than in Mexico, and has increased at a faster rate. The hourly wage for manufacturing workers in China was estimated to be at US$6.5 in 2020, a growth rate of over 12 percent from 2019. The hourly wage for manufacturing workers in Mexico, meanwhile, was estimated at US$4.82, a growth rate of just over 3 percent from a year prior.

Another consideration is the cost and time of shipping. Thanks to its proximity to the US, it is cheaper and faster to ship goods from Mexico than China. This is even more true in the post-COVID era, as the impact of the pandemic is still felt in the form of sky-high shipping costs.

Reasons companies choose to stay in China

Despite Mexico now offering lower manufacturing costs than China, there are other considerations when choosing which country to locate factories in – and whether to relocate. China has many other things to offer that make it attractive to companies, despite the higher shipping and labor costs.

These advantages include China’s robust manufacturing expertise, infrastructure, and well-developed upstream and downstream supply chains. China is the only country that possesses all the industrial categories in the United Nations industrial classification, which allows firms to source goods easily. The China labor market, in addition to being the largest in the world, is also increasingly skilled, holding advantages in expertise and efficiency over lower-cost emerging markets.

Stronger high-tech capabilities, such as digitization, automation, and data analytics, are also reasons that companies choose China over other countries, as they help to further improve production efficiency and can be conducive to developing more innovative business models. Sophisticated logistics and transport infrastructure – including the world’s largest network of high-speed rail and expressways in terms of mileage – allows products to be transported efficiently.

Another important factor to consider is that many companies do not produce goods in China exclusively to export to other markets. On the contrary, some companies – notably Tesla – set up factories in China specifically to sell to Chinese consumers. China is increasingly becoming a target consumer market for the goods produced by foreign companies within its borders, and China’s vast consumer base provides a strong incentive for manufacturers to be based in the country.

China’s consumer market is considerably larger than Mexico’s, both by the sheer number of consumers and by spending power. China is the world’s second largest retail market and is likely to be the first in the near future with China’s rising purchasing power, expanding middle class.  With a population of 1.4 billion versus Mexico’s 130 million, China provides a huge potential consumer base for any company looking to enter the market. GDP per capita is also higher in China, reaching US$12,551 to Mexico’s US$10,066 in 2021.

The growth rate of China’s economy has also far outpaced that of Mexico. Whereas China’s economy has grown at an average annual rate of almost 7 percent since 2011, whereas Mexico’s has grown at an average rate of 2 percent since 1993.

Reshoring to ASEAN and China+1

Although Mexico enjoys certain advantages over China as a destination for foreign manufacturers, we don’t expect there to be a mass exodus of foreign companies from China to Mexico. However, it is still worth pointing out that there are indeed companies seriously considering – and in the process of – reshoring from China. Many of these companies are also looking to “nearshore” to countries in the ASEAN region, taking advantage of the lower wages and looser COVID-19 controls in countries like Vietnam and Indonesia.

A business sentiment survey from the European Chamber of Commerce in China indicates that a quarter of 372 companies are considering relocating their current or future investments outside of China, but 77 percent surveyed companies said they have no such plans.  A survey made by the American Chamber of Commerce in China (AmCham) found similar trends.

However, rather than abandoning the Chinese market, investors are choosing to supplement Chinese operations with low-cost inputs sourced from production facilities in markets, such as Vietnam and Mexico. While the structures of these operations differ greatly depending on the country in question, this production model has become widely known as “China+1”.

Although Mexico may be a viable option for US companies focused on the North and South American markets, it is not as attractive for companies engaged in the European and Asian markets, which will include a large portion of US companies as well.

In the longer term, it is perhaps inevitable that companies will choose to reshore in a lower-cost country as China moves towards becoming a service-oriented economy, its population ages and workforce shrinks, and labor costs rise. However, it is possible that China will be able to maintain its competitiveness thanks to innovation in the manufacturing industry, its supply chain advantages, large consumer base, and favorable access to multiple markets via trade deals.

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