The Biggest US Trading Partner Is No Longer China!

As of July this year Mexico made up more of US imports than China did, and as the US seeks to rewire global trade Mexico could become the biggest beneficiary of these changes. Starting in 2018, the US administration imposed several rounds of tariffs on China and other US trade partners as part of Trumps "America First" economic policy. The aim was to reduce the US trade deficit by shifting American trade policy from multilateral free trade agreements to bilateral trade deals.

This round of tariffs was the first volley in the US China Trade war. Chinese goods suddenly got a lot more expensive for Americans and so they went shopping for goods from non-tariff countries that now appeared more affordable. For American manufacturers, the attraction of moving production from China to Mexico seemed obvious.

Mexico offered a skilled workforce, good transportation infrastructure, a huge shared border with the United States, an established export industry and privileged trade access. This seemed to be a once in a lifetime opportunity for Mexico, perhaps even more promising than the signing of the North American Free Trade Agreement had been in 1994. It didn’t really work out though, between 2018 and 2021 the proportion of manufactured goods imported into the US from Mexico rose a bit, but the big winners in global trade were low-cost Asian competitors including Vietnam and Taiwan.

Asian countries other than China increased their share of US manufactured goods imports from 12. 6 per cent to 17. 4 per cent over that period.

The Biden administration retained most of Trump’s tariffs when they took power, altering the rules slightly but mostly stacking more trade policies on top of the existing tariffs. Under president Biden, the trade war expanded to keep China locked out of US supply chains in a few key high-tech industries. Export controls on sensitive tech and investment restrictions were added.

When the pandemic struck in 2020 followed by Russia’s invasion of Ukraine last year, supply chains were thrown into chaos. China declaring a “no limits” friendship with Russia on the eve of the invasion, meant that the U. S.

and its allies stepped up their efforts to reduce dependence on China. The new complexity of global trade become a huge business opportunity, and Mexico found itself possibly better placed than almost any other country in the world to make the most of it. By now, even without the trade war, manufacturing wages had risen enough in China that it was no longer considered a low-cost country.

In the wake of all of these supply chain disruptions, businesses found themselves facing two options: They could fortify their global supply chains by building more slack into the system, reducing their reliance on just in time manufacturing by ordering supplies earlier and keeping bigger inventories of components - But this is expensive to do. The other option is to reduce the risks associated with political and geographical distance between a manufacturing location and the market by nearshoring. Between the trade war, the rising cost of Chinese labor and the simplicity of shipping goods across a land border rather than across the world’s largest ocean, Mexico, a nation with abundant natural resources, a young and productive workforce and a favorable location, overtook China as the biggest supplier of goods to their giant customer next door – the United States.

On top of growing exports, Mexico has the world’s strongest currency this year and one of the best-performing stock markets. Foreign direct investment is up more than 40% already in 2023 so far, not including the proposed $10 billion Tesla factory that is supposed to be built near Monterrey Mexico before 2026. Now, from a manufacturer’s point of view, Mexico is by no means perfect, there are many difficulties associated with manufacturing in Mexico and doing business in Mexico.

While China may be going through a difficult period, it is still a manufacturing powerhouse. China's first-rate infrastructure, which is not just its modern factories, but also its road, rail and port infrastructure is second to none in the world. This infrastructure is purpose built and optimized for high volume exports.

So will Mexico be able to compete with a nation like China? Now, Before I get to that I’d like to thank Ridge for sponsoring this video. If you’ve been considering getting a Ridge, now is the best time as you get the chance to win a brand-new Hennessey Ford Bronco – or $75 thousand dollars if you would prefer the cash.

Viewers of this channel get a 10% discount on all purchases. The Ridge wallet is much more than a money clip, it holds up to twelve cards – plus room for cash. There are more than thirty colors and styles available at every price point including the Black Damascus Steel one like mine.

I love how slim my Ridge Wallet is compared to the wallet I used to use. I also have the Ridge Key case which Securely holds up to six keys, without taking up loads of room in your pocket, and your keys don’t jingle constantly when you are driving your car. The Ridge team are so confident you’ll love their products, that they’ll let you try them out for 99 days and you can send them back for a full refund for any reason at all.

There is no purchase necessary for the Ridge Hennessey Sweepstakes, so enter for free at Ridge. com/Patrick. Find gear you’ll love and get additional entries for every dollar you spend.

If you use my link, you’ll get 10 bonus entries! And the discount code Patrick gives you 10% off your order. Thanks again to Ridge for sponsoring the channel, now back to the video.

As I was saying, there are difficulties associated with manufacturing in Mexico. Mexico does not score well on the corruption perception index, coming in at 128 out of 180 countries. It doesn’t rank well in terms of the ease of doing business either.

Its infrastructure needs a lot of work too, for example, its largest port is 1/6 the size of the Port of Los Angeles and Long Beach. Mexico has high mountain ranges, dense forests, and deserts in the north of the country all of which combined make moving goods around the country quite difficult. While companies like Apple have been diversifying their factory locations away from China to places like India and Vietnam.

As of today, if their factories in China were disrupted, they would be unable to manufacture on the same scale in any of these other locations and ship their goods all over the world. While many businesses in China are directly subsidized by the government, this indirect subsidy of building world class transportation and logistics infrastructure makes China formidable competition. The Mexican border state of Nuevo León has positioned itself to reap some of the bounty of the trade tensions between the United States and China.

Led by a brash, 35-year-old governor, Samuel García, the state has courted foreign investment while pursuing highway improvements to ease the movement of goods to border crossings. Connecting Texas and Nueva León is the World Trade International Bridge which ranks first among American points of entry in trade value. Manufacturing in Northern Mexico can offer one thing that China simply can’t—speed across the border and flexibility at low cost.

Companies can choose to relocate for a variety of reasons. Lego, Matel and Unilever are amongst a long list of companies that have announced big investments in nearshoring in Mexico. Chinese companies like Hofusan are building factories in Mexico too, in order to circumvent US tariffs.

BMW announced a large investment in Mexico to produce battery packs for its electric cars. This was likely driven by US subsidies provided in the Inflation Reduction Act, which includes Mexico. While the big drops in trade with China may give the appearance of US trade policy really working well, trade links between China and the US are enduring, but in considerably more tangled form.

Some of what is being hidden in the trade numbers is things like transshipment – which is the rebadging of Chinese goods to give the appearance that they come from another country. A good example of this from earlier this year is when the Department of Commerce found that quite a lot of Southeast Asian solar panel imports were made overwhelmingly of Chinese content. Over the decades, the collapse in global transportation costs meant that value chains stretched across sometimes dozens of countries.

The majority of international trade today consists of intermediate goods, rather than finished goods. Many of the goods being imported into the United States from Mexico will be made up of components that came from China. Finally, the vast majority of critical minerals and rare earths are processed in China, and these are vital components in many of the high-tech products that we use.

The US is still very much exposed to these supply chains, and is a long way from distancing itself from China in finding new suppliers. There is an argument that nearshoring and friendshoring mostly involves buying goods from other countries who are simply finishing goods that began their lives in China. Doing this rather than dealing directly with China might even have the effect of pushing American allies into a tighter relationship with the countries America is attempting to distance itself from.

While this is true, the more the United States trades with countries like Mexico, the more Mexico should develop and over time they might improve at manufacturing eventually being able to truly compete with China. There are big problems with water shortages in Mexico, particularly along the border with the United States where a lot of manufacturing is expected to happen. Only 58% of the country's population has daily access to running water.

This region’s natural resources might impose limits on potential growth. A drought last year left reservoirs in Nuevo León almost empty and thousands of residents without water. Local industry had to accept a smaller share of the state’s supplies.

The government is working to build a new aqueduct to bring water to Monterrey. There is also a shortage of electricity in Mexico, and there is a crucial link between water and energy issues. Electricity is needed to pump and to treat water.

Electricity is also needed for things like sewage treatment. In the United States, about 4 percent of power generation is used for water supply and treatment – almost as much as is used in essential industries like crypto mining. Taiwan-based Quanta Computer opened a factory two years ago in northern Mexico to build computers for Tesla cars.

The plant kept getting hit with power blackouts that took a chunk out of its productivity, because the electrical grid struggles to keep up with the fast-growing industries. The government of President Andrés Manuel López Obrador – nicknamed AMLO has received much of the blame for Mexico’s lackluster economic performance. The government has repeatedly clashed with business interests as it seeks to grow the state’s role in the economy.

Amlo has earned a reputation for being anti-business. He’s tried to curtail the role of foreign firms in Mexico’s energy markets and earlier this year dispatched troops to renationalize a privately run railway line, before reaching an accord with its owner. Mexican companies have been reluctant to borrow and make the needed investments that could help turn a growth spurt into something more enduring.

The country is up against fierce competition, from Vietnam and other nations, in the race to replace China as a supplier of choice to the US. Amlo came to power in 2018 on a left leaning, nationalist platform. He says that he dreams of restoring Mexico’s economy to the oil-powered, state-dominated days of the 1970’s and that he wants to create a “moral economy” that puts the poor first.

His regular naming and shaming of multinationals at daily news conferences doesn’t help instill confidence in foreign businesses considering investment into Mexico. The president’s obsession with what he calls “republican austerity” (he flies economy class and took a large personal pay cut) has meant salary reductions for top government officials. This in turn has led to a brain drain, budget cuts at government agencies and sharply reduced spending on infrastructure.

One indicator of whether nearshoring in Mexico is actually happening is the change in the share of trade with the US of Mexico and China respectively. If companies exporting to the US are relocating from China to Mexico, we would expect to see a fall in China’s share and an increase in Mexico’s. While Mexico did overtake China as the US’ top trade partner in the first two months of 2023, accounting for 15% vs China’s 14.

2%, the effect of nearshoring is less impressive when comparing the change in trade shares since 2017. While China’s share has fallen from 21. 6% to 14.

2% over this period, Mexico’s share only increased from 13. 4% to 15. 0% (or 1.

6%). China’s lost share has been captured mostly by other Asian countries like Vietnam. Things look more positive at a sectoral level.

The automotive sector, which accounts for 32% of Mexico’s non-oil manufacturing exports to the US, saw a strong increase of 5. 6% in US market share between 2017 and 2022. Iron and steel, a sector in which Mexico competes with China, also saw a 6.

4% increase. Other indicators we can look at are Foreign Direct Investment. If significantly more foreign companies were setting up operations in Mexico, we would expect a jump in FDI.

2022 FDI came to 35. 3 billion USD, with 48% of this being new investment, the highest in a decade. While total investment and new investment represents a 12% and 25% increase over 2021 respectively, some of the increase may represent delayed investment.

2022 FDI does not seem exceptional compared to the 2015-2017 period and is far below the 2013 peak. The increase in FDI in 2022 was partly driven by the merger of Televisa and Univision and the restructuring of Aeromexico, and thus unrelated to nearshoring. If we focus on the trend of total manufacturing FDI, it has not seen a dramatic increase.

This disconnect between media reporting of high-profile deals and the lack of a significant increase in investment may be down to time lags, but it is also a reminder that specific investments are not necessarily evidence of nearshoring. If nearshoring was definitely happening on any sort of large scale you’d expect to see investment in Mexico and a corresponding divestment from other countries. We are not really seeing any evidence of that happening yet.

While we have seen some data to support the reality of nearshoring such as industrial park occupancy and job creation, the effect has been small in the headline trade and FDI statistics. This could lead us to conclude that the effect of nearshoring has possibly been overhyped. If nearshoring really is happening, but is slow to show up in the data, this could be explained by the amount of time it takes to move a business.

Additionally, the current governments anti-business stance might be holding back big changes in investment, as business leaders might be waiting to see the results of next year’s elections before deploying significant amounts of capital. A report by The Economists’ Intelligence Unit (the research and analysis division of the Economist Group) shows that on several broader factors of business environment Mexico compares unfavorably with Asian competitors, including China, Thailand and Malaysia. Mexico scored poorly on political effectiveness, private enterprise policy, infrastructure and technological readiness, although Vietnam and Indonesia scored even lower on most of these metrics.

Moreover, they say that Mexico remains unprepared to take market share in the most high-profile sectors in the decoupling between the US and China, such as the semiconductor sector. At present there are only weak indications that nearshoring is already happening in Mexico, but that might change in the coming months or years. A big factor that might drive nearshoring to Mexico in the coming years is Mexico’s inclusion in the subsidies under the US Inflation Reduction Act which was put in place to attract more green industries to set up in North America.

Mexico’s milestone of overtaking China in trade with the United States, may indeed reflect a real shift in the dynamics of the global economy — away from focusing only on low prices (via fragile supply chains) to something more nuanced. Today’s global economic relationships increasingly appear to take into account a long list of non-price concerns, among them national security, climate policy and supply-chain resiliency. Ultimately, Mexico’s greatest appeal to global businesses looking to relocate may rest mostly on its geographic location and its free trade agreement with the United States.

China still towers over every other country in global manufacturing, but a growing list of factors has prompted companies to search for a backup – what has become known as the China plus one strategy. First, there were rising labor costs in China and pressure from the Chinese government to transfer technology to Chinese competitors. Then there were the US tariffs on Chinese imports in 2018, Covid lockdowns from 2020 through last year, and now a push by Western governments to decouple their economies from China.

Many countries are competing to be the “plus one,” like Mexico, India, Vietnam, Thailand and Malaysia, and we will have to wait and see who the winners will be. Declining trade with China should mean rising costs for western consumers and companies as making these changes won’t be cheap as all sorts of new infrastructure will be needed. These changes also reflect worsening diplomatic relations between China and the rest of the world — which is concerning for reasons that go beyond economics and finance.

It can be argued that aside from arguments of friendshoring or nearshoring there are good economic reasons for Washington to encourage switching production from countries that run large persistent trade surpluses like China, Australia, Germany and Ireland do to countries like Mexico, that have balanced trade, or even trade deficits. Increasing trade with countries like this could be expected to increase global demand and increase US exports in line with any increase in US imports. The reason for this is down to the different ways in which China and Mexico deal with export revenues.

When a country imports goods from Mexico, Mexico uses the incoming foreign exchange to buy goods from the rest of the world. China instead stores a lot of that foreign exchange as central bank reserves, refusing to import from other countries. Because wages and household income make up a higher share of Mexican output, when you buy goods from Mexico, Mexican consumption and thus imports rise just as fast, or even faster than exports did, meaning that buying from a country like Mexico increases global demand and global economic activity, which is good for the country that bought goods from Mexico.

Mexican export revenues, in other words, are converted into imports, and while only some of these imports might come directly from the United States - because trade has to balance globally, in the end total US exports should rise by as much (or more than) the increase in US imports. Now, this is not what happens when a US business relocates to a trade surplus country, or when goods are bought from a country who has a strategy of running a persistent trade surplus. In that case the workers receive a much lower share of what they produce, and part of the country's export revenues are (instead of being used to import goods) converted into savings.

These savings are exported abroad (buying things like treasury bonds), and because the world has excess savings, they end up representing a net reduction in the amount of global demand caused by the shifting of production from a balanced trade economy to a country that runs persistent trade surpluses. In a well-functioning global trading regime, shifting production abroad is part of the process by which countries specialize in production of goods and everyone wins due to comparative advantage. In a trade regime like that, more US imports would simply convert into more US exports, but that's not how the global trading system works.

Countries that succeed in weakening domestic demand through foreign exchange manipulation, or keeping wages low are rewarded with rising trade surpluses, and these bring about a reduction in global demand that ultimately prevents other countries exports from balancing with their imports. If you enjoyed today’s video, you should watch this one next. Don’t forget to check out our video sponsor Ridge by clicking on the link in the video description.

Have a great day and see you in the next video. Bye.