A famous Mexican president once said, “Poor Mexico, so far from God, so close to the U.S.” Little did he know at the time that such proximity would someday hold tremendous economic opportunity.
“Nearshoring” means moving all or part of a business operation to a nearby country from one farther away. Geopolitical tensions, trade policy, ballooning transportation costs, COVID-19-related shutdowns and increased compliance costs for sourcing goods from the People’s Republic of China have encouraged manufacturing companies to nearshore their operations closer to the United States, especially to Mexico.
Since the North American Free Trade Agreement (NAFTA) was implemented in 1994, Mexico has been the recipient of a healthy investment boon in foreign direct investment (FDI). According to World Bank figures, in 1993, Mexico received USD$4.39 billion in FDI before expanding rapidly and reaching over $30 billion for the first time in 2001―with a high in 2013 of $50.83 billion. Mexico’s FDI has surpassed $30 billion in six of the past seven years and most recently was $35 billion in 2022. NAFTA gave foreign investors preferential duty treatment, access to the biggest consumer economy in the world and, perhaps most importantly, legal certainty and protection of their investments. Almost 30 years later and despite the current political rhetoric, Mexico continues to be a magnet for manufacturing sectors. Nowhere is this more evident than in the automobile industry. Since NAFTA was implemented, Mexico has become a manufacturing hub for Asian and European vehicle and vehicle part producers. In 2017, the United States, Mexico and Canada started NAFTA’s renegotiation to reflect modern business practices. As a result of these negotiations, the United States-Mexico-Canada Agreement (USMCA) took effect July 1, 2020. Among other things, the USMCA increased regional value content requirements for products to be considered to be made in North America. Consequently, the increased requirements also gave an incentive to foreign producers to relocate their supply chain to North America.
On March 1, 2023, the United States Trade Representative (USTR) released President Joe Biden’s 2023 Trade Policy Agenda and 2022 Annual Report. In it, the USTR highlighted USMCA’s Rapid Response Mechanism (RRM). The RRM allows the United States to quickly take action and target specific facilities in Mexico where workers are being denied their rights to freedom of association and collective bargaining. The RRM is a tool intended to level the playing field for U.S. workers. USTR Ambassador Katherine Tai has worked with labor representatives in Mexico to invoke the RRM to resolve multiple violations of workers’ rights, which included securing reinstatement and backpay to workers who were allegedly terminated for participating in union activity.
Mexico shares a 2,000-mile border with the United States. It has free trade agreements with over 40 countries and has an ample, young, skilled and cost-efficient labor force. Time zone differences are not an issue and shared cultural and business values ease economic dealings. Mexico also offers benefits similar to those of a U.S. foreign trade zone through its IMMEX program. Articles are exempt from taxes and duties provided certain requirements are met. However, not everything comes without challenge as the country continues to struggle with security issues, corruption, lack of infrastructure (mainly energy) and industrial park availability. Energy policies recently adopted by current Mexican President Andres Manuel Lopez Obrador have disheartened some investors. Currently, the United States, Mexico and Canada are engaged in an energy dispute that may end up with the implementation of an arbitral panel under Chapter 31 of the USMCA dispute settlement mechanism.
While nearshoring in Mexico is starting to become a reality on a large scale, companies looking to do so still face many obstacles. The main obstacles for new entrants are the lack of industrial real estate and access to reliable energy. A common mistake by new entrants is not properly managing time expectations for projects. Mexico’s governmental agencies (at federal, state and municipal levels) in charge of issuing permits required to open and operate a manufacturing facility are notoriously difficult to navigate and time consuming. Mexico’s labor laws are employee-friendly, and failure to assess employment risks or adopt mitigation strategies have proven costly for many new entrants. Notwithstanding the challenges in Mexico, increasing tensions with China as well as reinforced U.S. policies encouraging regional production as part of its plan to secure the supply chain have made Mexico a prime location to consider nearshoring or “friendshoring” operations.
Impact of Trade Policy in Nearshoring Operations
To say that the trade relationship between the U.S. and China is very complex is an understatement. The relationship is mainly driven by national security considerations as opposed to economic rationale. This heightened complexity will increase costs for any company doing business with China, hence making Mexico a more attractive consideration for nearshore operations. Some examples of the fraught trade policy changes in the last couple of years include:
Section 301 Tariffs
In 2017, the United States launched an investigation under Section 301 of the Trade Act of 1974 conducted by the USTR. The reason for the investigation was predicated on China’s acts, policies and practices related to technology transfer, intellectual property and innovation. In March 2018, after considering public comments, the USTR issued a report concluding that China’s intellectual transfer regime is unreasonable or discriminatory and burdens or restricts U.S. commerce. As a result, under the Trump administration, the U.S. imposed Section 301 tariffs on imported goods of Chinese origin through four lists that were sequentially enacted that have a total annual trade value of approximately $370 billion. While these Section 301 tariffs issued pursuant to List 3 and List 4A are being challenged at the U.S. Court of International Trade and the USTR is conducting a review of the tariffs as required by the trade statute, it seems rather unlikely that the Section 301 tariffs will be eliminated in the near future.
Uyghur Forced Labor Prevention Act
On December 21, 2021 President Biden signed the Uyghur Forced Labor Prevention Act (UFLPA) into law, which entered into effect on June 21, 2022. The UFLPA establishes a rebuttable presumption that imports of all goods, wares, articles and merchandise mined, produced or manufactured wholly or in part in Xinjiang, or mined, produced or manufactured by certain entities on the UFLPA Entity List, are presumed to be made with forced labor and are thus prohibited from entry into the United States. The UFLPA presumption applies unless U.S. Customs and Border Protection determines that it has been rebutted (i.e., that the importer has complied with specified conditions and, by clear and convincing evidence, has demonstrated that the items were not mined, produced or manufactured wholly or in part by forced labor). The presumption also applies to goods made in or shipped through China and other countries that include inputs made in Xinjiang. There is no de minimis safe harbor; as a result, if a single tire in an automobile was produced with forced labor, the entire vehicle will be denied entry into the United States.
Semiconductor Export Restrictions and Incentives
The U.S. Department of Commerce’s Bureau of Industry and Security (BIS) implemented a series of targeted updates to its export controls as part of its efforts to protect U.S. national security and foreign policy interests. These amendments to the Export Administration Regulations (EAR) administered by BIS will restrict the ability of China to purchase and manufacture certain high-end chips used in military applications and build on prior policies, company-specific actions and less public regulatory, legal and enforcement actions taken by BIS.
The Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act) was signed into law in August 2022 and provides $52.7 billion in incentives to American semiconductor companies for research, development, manufacturing and workforce development. Of those incentives, $500 million is for international information communications technology security and semiconductor supply chain activities. Reports from President Biden’s trip to Mexico in early January 2023 indicate that both countries have agreed to coordinate investments in semiconductor manufacturing. Secretary of Commerce Gina Raimondo, whose department is leading the implementation of the CHIPS Act, remarked that Mexico could benefit from housing the manufacturing facilities for semiconductors. In addition, the CHIPS Act provides safeguards that prevent fund recipients from expanding or advancing semiconductor manufacturing capabilities in foreign countries of concern like China.
The Tariff Response
The People’s Republic of China responded to U.S. trade policy by adopting retaliatory tariffs on U.S. products imported to China. In addition, China has enacted laws that make it illegal for Chinese firms to comply and cooperate with information requirements from the United States. The United States continues to aggressively use its arsenal of trade remedies such as the Section 232 steel and aluminum tariffs and anti-dumping and countervailing duties. Given recent events and increased geopolitical tension, more restrictive actions are likely and will further encourage companies to nearshore their operations to a friendlier environment. Therefore, Mexico presents itself as a seamless and promising platform to develop, expand and consolidate a significant market presence in North America.
In summary, there are numerous reasons why Mexico will be a critical player in the massive supply chain realignment that the Biden administration is seeking to create. Accordingly, there are great opportunities that U.S. and Mexican companies can seize that establish effective North American supply chain partnerships, especially ones that develop effective strategies for taking advantage of duty preferences under the USMCA and/or funding under the CHIPS Act.