Let’s talk about Nearshoring 3.0 | Quarterly Report | February 2024

Mexico has become the United States’ main trading partner

The trade dispute starter by former President Donald Trump in 2016 has a clear winner: Mexico. In 2023, Mexico surpassed China and became the United States’ main trading partner. The trade relationship between Mexico and the U.S. has grown significantly over the past seven years. In 2016, the trade exchange amounted to $482 billion. By the end of 2023, this amount had risen to $745 billion, representing a growth of over 50% during that period. In recent years, Mexico has gained just over 1.5 additional percentage points of the imports that the United States takes in from the entire world, but there is still much ground to cover.

In Mexico, $36.058 billion in Foreign Direct Investment (FDI) were brought in in 2023, according to timely data from the Ministry of Economy. Organic growth set at 23%, considering the fact that, in 2022, there were extraordinary events such as the capitalization of Aeroméxico and the Televisa-Univisión merger, which, when included, resulted in a slight 1.0% decrease in FDI, according to revised figures from the Bank of Mexico and timely data from the Ministry of Economy. In 2021 and 2022, FDI grew by an average of 14%, according to the Central Bank of Mexico.

Regarding the components of Foreign Direct Investment, 74% corresponds to reinvestment of profits, 13% to new investments, and the rest to accounts between companies. It’s worth pointing out that, as of 3Q23, new investments only represented 8% of the total flows from abroad, while by the end of 2023, this figure accelerated to represent 13%, which is a larger percentage of the total. According to our calculations, FDI in the last quarter of the year amounted to $3.131 billion, reflecting a growth of 73% compared to what was logged in 4Q22. Traditionally, FDI tends to be very high in the first quarter of the year, as this is the season for reinvesting profits due to dividend payments. In a pro forma manner, we estimate that profit reinvestment in the last quarter of the previous year amounted to 55% of the total, reaching $1.725 billion, while new investments represented 65% totaling just over $2.011 billion (inter-company accounts subtracted $605 million).

It’sworth noting that global FDI flows were 15% lower considering the first three quarters; in contrast, Mexico was one of the few attractive investment winners worldwide. Considering the country of origin, the top three were the United States, Spain, and Canada. By state, 31% of the investment was concentrated in Mexico City, 8% in Sonora, 7% in Nuevo León, and the remaining amount in other states.

Looking ahead, understanding and managing risks is essential for operational efficiency and attracting investment in nearshoring. The main risks include: 1) infrastructure, 2) energy and water, 3) the risk of a focus on traditional manufacturing instead of higher value-added sectors, and 4) the lack of public safety.

Mexico’s impact on US imports

Mexico’s participation on US imports holds the top position, and, of course, various media headlines have not missed the opportunity to mention the fact. However, regarding imports, Mexico was not the sole winner.

With data through the end of 2023, we find interesting information for Mexico. For example, the country increased its share from 43% to 46% in auto parts, growing by 13.1% last year, well above the sector’s overall growth of 5.1%. China, on the other hand, again decreased its share in US imports of auto parts from 12% to 10%. In the new car sector, the country remained stagnant with a 21% share in 2023, although it’s noteworthy that Canada and South Korea increased their shares from 16% to 17% and from 13% to 15%, respectively. The auto and auto parts sectors together amounted to $344.655 billion in 2023.

In the computer and computer accessories sector, Mexico had mixed results. In the former, its share decreased from 34% to 29%, and in the latter, it increased from 6% to 7%. Additionally, it’sworth highlighting that the computer sector declined by 14%, and accessories decreased by -13%, both compared to 2022. On the other hand, Taiwan stands out in both sectors, growing by 44% in computers and 26% in accessories, increasing its share from 8% to 13% and from 18% to 26%, respectively. Both sectors amount to $155 billion.

The medical equipment category reached $57.825 billion in 2023, a 2% increase in total, while Mexico grew by 22%, both figures compared to 2022.Mexico’s share increased from 20% in 2022 to 24% in 2023.

In the alcoholic beverages sector, excluding wine, Mexico holds a 43% share of US external demand, +3 percentage points above 2022 and more than double compared to 2019. Alcoholic beverage imports are close to $11 billion.

In conclusion, it must be acknowledged that Mexico continues to gain more market share in the automotive, alcoholic beverages, and medical equipment sectors. However, in sectors where it had the lead, such as computers, there is evidence of Asian economies starting to gain market share. The country must strengthen existing strengths and seek new areas to leverage nearshoring. The most significant challenge to overcome is transitioning from becoming a manufacturing hub to a technological hub where other areas can benefit from the relocation of supply chains.

High demand for industrial real estate

One of the sectors in which the impact of new investments has been most evident is the industrial real estate sector, due to increased demand for space from companies entering the country or, already established and seeking expansion. According to data from the Mexican Association of Private Industrial Parks (AMPIP for its acronym in Spanish), industrial parks closed 2023 with a 2.2% vacancy rate, a stable level compared to 2022 (2.1%) but below the levels of around 6% seen between 2019 and 2020.

On the other hand, according to CBRE, at the end of 2023, the net absorption of industrial space in Mexico (new occupied space minus vacant space) grew by 16% YoY, while demand associated with nearshoring would have represented 1.7 million square meters in 2023, 5% growth compared to 2022, mainly driven by the automotive and electronics & appliances sectors, especially in the northern part of the country. Demand associated with nearshoring would have represented 28% of the total demand for industrial space in 2023.

By destination, the main beneficiaries of space demand due to nearshoring are the border states; for example, Ciudad Juárez concentrated 27% of the demand in 2023, followed by Monterrey, which accounted for 24%. Together, the northern states of the country received 80% of the demand for space, while the rest of the markets in the country received 20%.

Another piece of data reflecting the dynamism of the industrial real estate sector is the amount of investments allocated to it. AMPIP estimates that in 2024, its members will invest $3.185 billion, which would log 14.2% growth compared to the 2023 investment, which closed at $2.79 billion.

Nearshoring Challenges

Understanding and mitigating risks is crucial to lighten the difficulties that international companies may encounter in their pursuit of greater operational efficiency. This, in order to attract investment and capitalize on the opportunities offered by nearshoring. Among the most significant risks, the following stand out:

1. Infrastructure: The challenge is to enhance the connectivity of logistical infrastructure, increase capacity in ports, roads, and railways, and make improvements in telecommunications.

2. Energy and water: Some real estate investment trusts (REIT’s) in Mexico have reported that in markets with lower occupancy levels, there hasn’t been enough secured energy to meet the nearshoring needs of tenants. Additionally, water plays a crucial role in manufacturing, textile production, chemical and pharmaceutical industries, and agricultural production. This is relevant as the country faces severe and extreme droughts in a significant part of its territory.

3. Traditional manufacturing vs. higher value-added: While growth has been observed in traditional manufacturing sectors, higher value-added segments, such as electronics, information technologies, and aerospace, have not experienced significant growth. This could be attributed to the lack of legal and political certainty in recent years, which is essential for attracting long-term investments in capital-intensive sectors. With this context, the risk is that, although exports and employment may increase for a few years, significant transformation may not be achieved if nearshoring is limited to reviving traditional manufacturing instead of becoming a more comprehensive process that includes long-term investments, technology transfer, and human capital development.

4. Lack of public safety: High levels of public insecurity create a negative perception in the investment climate. Investors may perceive an increase in risks to the security of their personnel, assets, and operations; an insecure environment can lead companies to incur higher costs (security measures, surveillance systems, insurance costs), making the investment less attractive.

In conclusion, it’s worth noting that if Mexico wants to capitalize on the nearshoring opportunity, there are still things to be done. It is not just about attracting investments with more attractive fiscal incentives and addressing the aforementioned issues. The strategy is to attempt to create an “onboarding package” to welcome new companies interested in investing in Mexico, guiding them from legal, fiscal, financial, and strategic perspectives, and creating an experience that could significantly facilitate the relocation of supply chains. Nearshoring is not a phenomenon that can be clearly evidenced overnight; it is something that will happen over time. Opportunities exist, and we must seize them.