Mexico Street View: The nearshoring neighbor

On our recent visit to Mexico, signs of nearshoring were everywhere in Monterrey, the capital of the northeastern state of Nuevo León and the second largest city in Mexico. The boom in construction in the city was remarkable in scale and volume, reflecting robust economic activity for the state. Reports of a similar surge across the rest of northern Mexico are lifting prospects of revitalization for the country. We are upbeat about Mexico and see positive implications for the emerging market (EM) investment universe.

Relocating supply chains

Nearshoring to Mexico moved into overdrive when COVID shut down manufacturing lines in China, and port congestion and the Suez Canal obstruction caused major disruptions to global supply chains. Compounded with rising US-China tensions, these made sourcing production from far flung places untenable and accelerated the relocation of supply chains from global to regional.

As businesses become wary about being over-reliant on a single source of production like China, nearshoring to Mexico is both strategic and pragmatic.

Why Mexico

Monterrey is a three-hour drive from the US border. The geographic proximity is a big advantage for nearshoring but, more importantly, Mexico is the only developing country that has free trade agreements in place with the US, Canada, the European Union and Japan.

Among them, the United States-Mexico-Canada Agreement (USMCA) is a modernized and renegotiated version of North American Free Trade Agreement (NAFTA). The framework came into effect in 2020 to support mutually beneficial trade and economic growth in North America. US tax credits are also available for qualified North American manufacturers that produce parts and components for solar panels, electric vehicles and semiconductors.

Formalize an economy

The massive expansion of manufacturing across the US-Mexico border is clear to see through the window of Monterrey. As a hub, the scale of industrial construction reminded us of the rapid development in China. Residential construction also kept pace as workers move from the south to take jobs in the north of the country. We believe this fast urbanization will lead to a major formalization of the economy.

Today, 50% of Mexican people hold informal jobs (often with poor pay) in the south and about 30% in the north. The informal economy provides employment and income for many, but creating an economy with more formal employment is key to long-term welfare creation, stability and poverty reduction.

When compared to 13.5% in OECD (Organization for Economic Cooperation and Development) countries, we estimate that Mexico’s informal employment will fall significantly in the next five to 10 years as part of the downstream impact of nearshoring. It will broaden the tax-paying base and bring in higher tax income, which we think could have positive effects on the quality of the economic growth and investment in the future of the country.

New projects and jobs in Nuevo León

We spoke with local bankers, developers and government officials on our trip and found sentiment to be very positive across the board. Anecdotal media reports and our on-the-ground observations support this, and official numbers tell the same story.

According to data from the Office of Nuevo León’s Secretary of Economy, foreign direct investment (FDI) ranged from US$1-1.5 billion on an annual basis a few years ago. It went up to US$4 billion in 2022 and is projected to come in around US$8 billion in 2023.

Among the projects that broke ground in Nuevo León in 2022, 75% were related to nearshoring. Somewhat unsurprisingly the majority (50%) came from American businesses. However, 21% of the businesses relocated from China, compared to none just two to three years ago. Higher tariffs on Chinese imports into the US and COVID-related lockdowns are major factors for this shift. The remaining came from Asia ex-China (16%) and Europe (13%).

In-state jobs are growing at five times the rate before 2020, and the current cycle is expected to create half a million new jobs in total, almost 9% of the state’s current population. This red hot job market is driving immigration to Nuevo León, registering 120,000 arrivals in 2022.

The strong job market bodes well for salaries, which are growing at 5% in real terms, albeit from very low levels. Rising income should drive consumption, especially spending in staples such as food retail.

Where to invest

Several multinational beverage and retail companies as well as hypermarket and grocery store chain operators talked to us about the competition heating up. Consumer staples companies are gaining from the increased spending; general merchandise such as apparel, home appliances, televisions, furniture and so on are selling well. At the same time, retailers have taken steps to stay competitive by improving logistics, technology, loyalty programs and payment systems. We see investment potential in companies capitalizing on the consumption trend.

Elsewhere, building materials companies should benefit from the nearshoring-related construction boom. Longer term, select banking and financial services companies appear to be attractively priced and well positioned for the country’s growth trajectory.

Infrastructure risks

For all the positives, however, there are risks to Mexico’s nearshoring story.

A strong infrastructure is critical to a thriving manufacturing hub, but a lack of public investment in electricity capacity and transmission lines has resulted in power disruptions and outages in parts of Mexico as energy demand grows. There needs to be a focused effort in modernizing an old electricity system and speeding up transmission to local grids in places like Nuevo León.

The cancellation of the Texcoco Airport project in late 2018, a new international airport for Mexico City, also drew criticisms against the government. Protests against the government’s land acquisition tactics and the aftermath of the scrapped plan then depressed private sector investment. A much scaled down airport opened last year at a different location outside of the city center but failed to quell the negative sentiment.

For the strong job market trends to continue, the talent pool also needs to keep pace, so that salaries would not reach unsustainably high levels.

Choice partner

In aggregate, we are upbeat about Mexico. We believe it presents attractive investment opportunities and supports the long-term case for EM investing.

The transformations occurring in cities like Monterrey make it clear to us that nearshoring is altering Mexico’s foreign investment and economic picture in the present and for the long term. Well placed to help businesses overcome sourcing challenges and ensure competitive advantages, Mexico stands to gain from a greater integration of production across the region.

We see Mexico as a nearshoring destination of choice for US businesses and more, which could present a large set of investment opportunities.