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Shifting Trade Lanes
Rewiring of the great American supply chain
In 2023, the United States found a new friend in Mexico. In that year, the total trade between the U.S. and Mexico reached approximately $799 billion, making Mexico the United States' top trading partner and pushing China to second place—a position it held for nearly two decades.
So, what catapulted Mexico to the forefront of the U.S. trade partnership? This shift was propelled by multiple factors: evolving global supply chains, strategic trade policies, shifting geopolitical dynamics, and a deadly virus! Interestingly, Mexico's journey to becoming a coveted manufacturing hub and vital supply chain player didn't happen overnight. This ambitious transformation traces its roots back to the 1960s. Let’s travel back in time and look at the events that have played a defining role in the US-Mexico trade relationship.
Back to the Future
Significant rural poverty and limited industrial opportunities were crippling the Mexican economy in the 1960s. To address these issues, the Mexican government introduced maquiladoras under the Border Industrialization Program (BIP) in 1965.
So, what are maquiladoras?
Maquiladoras are manufacturing plants in Mexico that import raw materials and components duty-free for assembly or manufacturing and then export the finished products, primarily to the United States. This system was designed to promote industrialization along Mexico's northern border and attract foreign investment.
Credit: The Jus Semper Global Alliance
Did maquiladoras achieve what they set out to do? Indeed, they accomplished that. The maquiladoras increased local employment and boosted the economy of the border villages, which were plagued by poverty and unemployment. Simultaneously, they helped US manufacturing companies with access to a cheap workforce and reduced labor costs. Furthermore, Mexico's geographical proximity to the US reduced transportation costs and time for the companies compared to other offshore locations.
These lucrative factors helped maquiladoras mushroom in the US-Mexico borders like wildflowers after a spring rain. An International Labor Organization report states that the number of maquiladoras in Mexico grew from 50 small establishments in 1965 to nearly 800 in 1985, and by 1990, there were roughly 1900 plants employing about 460,000 people.
The report further states that Mexico’s exports experienced significant growth over the next few decades. The total maquiladora exports soared from almost US$2.5 billion in 1980 to US$10.1 billion in 1988.
Thanks to the flourishing maquiladoras, driven by bold economic reforms, the privatization of state-owned enterprises, and Mexico’s entry into the General Agreement on Tariffs and Trade (GATT) in 1986, the country was experiencing a remarkable economic renaissance.
By the 1990s, many leading companies, such as General Motors, General Electric, Hewlett-Packard, Ford, Chrysler, Samsung, etc, had major maquiladora operations in Mexico. However, the watershed movement in Mexico’s economic history, which helped Mexico transform into a key supply chain entity in North America, happened in 1994 in the form of a trade agreement.
The year 1994 saw the world break down many barriers, both economically and politically. Nelson Mandela became the first Black president of South Africa, ending the political darkness cast by apartheid. In the Western Hemisphere, the world's largest free trade agreement — the North American Free Trade Agreement (NAFTA) — came into effect and removed economic barriers by eliminating tariffs and boosting investment between the United States, Mexico, and Canada.
Leaders from the United States, Mexico, and Canada signed the NAFTA treaty on October 7, 1992, in San Antonio, Texas
Source:CNBC.com
Mexico was finally shedding the burdens of its debt crisis and hyperinflation, attracting a surge of foreign investment and modernizing its industries. And what’s the best way to attract FDI than teaming up with the richest country in the world? The agreement was Mexico’s shot at achieving economic growth, drawing foreign investment, modernizing its economy, creating employment, and enhancing its geopolitical standing.
For the United States, NAFTA was not just a strategic move to cement its economic influence in the Western Hemisphere but the creation of integrated supply chains across North America, lowering production costs and increasing efficiency for U.S. manufacturers, a natural successor of the Border Industrialization Program (BIP).
Data source: US Census Bureau
The NAFTA Effect
The expectation of NAFTA was to lower or completely eliminate tariffs and significantly increase cross-border trade — which it spectacularly did! In fact, NAFTA, according to trade experts, passed the test with flying colors and made significant contributions to the economic landscape between the United States, Mexico, and Canada by eliminating most tariffs on goods traded across the border and drastically increasing the trade volume.
Between the US and Mexico, it spurred a remarkable increase in trade volume, with bilateral trade soaring from $81 billion in 1993 to over $614 billion by 2020. The import-export between Canada and Mexico saw a whopping 10x growth between 1993 to 2018.
Over the years, NAFTA has been credited with various positive outcomes, such as increased economic growth, the creation of more jobs, a unified North American front, etc. However, according to experts, the most valuable outcome of this historic deal is the development of a robust supply chain system between these countries. This expansion has fostered vertical supply relationships, particularly along the U.S.-Mexico border. The region became a crucial production hub, with U.S. industries like automotive, electronics, appliances, and machinery heavily relying on Mexican manufacturers.
Geronimo Gutierrez, former managing director of the North American Development Bank (NADB), noted, "By promoting the tight integration of North American industrial supply chains, NAFTA is creating partners and not competitors among its member countries," according to the Wharton Business Journal.
According to a study by the National Bureau of Economic Research, 40% of the content in U.S. imports from Mexico is actually of U.S. origin. Additionally, the study states that goods from Mexico and Canada make up about 75% of all U.S. domestic content that comes back to the U.S. as imports.
Data source: IMF and World Bank
A 2017 Congressional Research Service report on NAFTA states that Mexico became a more significant trading partner in the motor vehicle market as U.S. auto exports to Mexico increased 262% while imports increased 765% between 1993 and 2016. Furthermore, automobile giants like General Motors and Ford integrated their supply chains across North America. Imagine this: most cars that the average American drives will have engines manufactured in Canada, transmissions in Mexico, and final assembly in the U.S., and the warehouses and logistics hubs along the border will facilitate the movement of these components.
"NAFTA helped the U.S. auto sector compete with China by contributing to the development of cross-border supply chains, lowering costs, increasing productivity, and improving U.S. competitiveness," said Gordon Hanson, professor at Harvard Kennedy School.
You might now think that NAFTA sounds like a sweet win-win deal for all parties involved, fostering growth and finally forming that all-powerful North American bloc. The signing leaders probably thought so, too.
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NAFTA will tear down trade barriers between our three nations, create the world’s largest trade zone, and create 200,000 jobs in [the U.S.] by 1995 alone. The environmental and labor side agreements negotiated by our administration will make this agreement a force for social progress as well as economic growth
- President Bill Clinton
However, reality hit hard in the form of a debt crisis, job losses, infamous trade deficits, and several economic recessions. Sadly, NAFTA was not a utopic trade agreement that was all roses. It had its own fair share of thorns. For instance, the agreement was heavily criticized for displacing manufacturing sector jobs in the U.S. and increasing trade deficits in the United States.
Across the border in Mexico, in spite of the creation of more jobs, particularly in the maquiladora sector, economists and trade experts criticized NAFTA for the low wages it offered to Mexican workers compared to their American counterparts. Experts also believe that NAFTA played an influential part in the debt crisis and economic slump that Mexico encountered in the latter half of the 1990s.
Policymakers and leaders from all three countries soon realized that NAFTA was no match made in heaven; in fact, it was a marriage of convenience! Enter the United States-Mexico-Canada Agreement (USMCA), a deal drafted to restore the lost relationship.
Finally, on Nov. 30, 2018, the United States-Mexico-Canada Agreement (USMCA) was signed, putting NAFTA to rest. It was replaced primarily due to the need for modernization, addressing perceived trade imbalances and political pressures. The USMCA aimed to create a more balanced and updated trade agreement, with enhanced provisions for labor, environment, digital trade, and stricter automotive rules of origin.
The New Deal
The USMCA, or NAFTA 2.0, significantly enhanced the original NAFTA framework, addressing contemporary trade challenges and opportunities. One of the notable changes was the stricter rules of origin (ROO) for automobiles, requiring that 75% of a vehicle's components be manufactured in North America to qualify for zero tariffs, up from 62.5% under NAFTA. This adjustment is particularly beneficial to Mexico's automotive industry, encouraging more production within the region and ensuring that Mexican factories remain integral to the supply chain.
NAFTA was a permanent agreement with no formal mechanism for periodic review, which was cited as its biggest drawback. However, the USMCA includes a 16-year sunset clause with a requirement for a joint review every six years, allowing for adjustments and updates to ensure the agreement remains relevant.
Furthermore, with the implementation of USMCA, the United States retained its high de minimis threshold of $800. This high threshold, coupled with the tariff-free provisions of Section 321, offers substantial benefits for manufacturers of low-value goods and SMEs.
Source: US Census Bureau
Let’s explain what Section 321 is. It is a statute in the U.S. Tariff Act that allows businesses to import a low-value shipment, duty-free, into the U.S. when the total value of the shipment is $800 or less. This exemption is called de minimis entry, and these shipments are eligible for informal entry by air, land, or sea and use all commercial ports of entry.
The rise of cross-border e-commerce has been significantly driven by the advantages provided by Section 321 and the USMCA. These regulatory benefits have greatly boosted the growth of ecommerce facilities in Mexico's border towns.
Section 321 of the U.S. Tariff Act and USMCA have helped e-commerce businesses avoid tariffs on goods valued at $800 or less per shipment and facilitate a smooth passage into the American border.
Furthermore, Mexico's strategic location and access to cheap labor make it an ideal spot for U.S. companies to set up and expand their fulfillment operations. The availability of skilled labor and lower infrastructure costs compared to the U.S. add to the appeal, driving the significant rise of cross-border e-commerce fulfillment setups.
A War and a Virus
Donald Trump and tariffs are an age-old love story. A love affair he has no qualms about announcing in public.
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“I believe very strongly in tariffs,” said Mr. Trump to journalist Diane Sawyer when he was a Manhattan real estate developer. He then went on to criticize Japan, West Germany, Saudi Arabia, and South Korea for their unfair trade practices, according to a New York Times report. “America is being ripped off,” he added. “We’re a debtor nation, and we have to tax, we have to tariff, we have to protect this country.”
Three decades after this statement and a presidential victory later, Trump, in 2018, imposed new trade barriers and tariffs on China and set off what is termed the “US-China Trade War.”
According to the U.S. Census Bureau, since July 2018, Chinese exports to the U.S. have dropped by 21%, and – no points for guessing — this void is now filled by Mexico, which has now become the leading supplier of goods to the U.S. In 2023, Mexico's exports to the U.S. grew by 4.5%, while China's exports decreased by 20.4%, and Canada's fell by 3.8%. This growth was driven by the geographical proximity of Mexico and the longstanding trade relationship between the countries.
The man-made war was not the only factor that caused the US-China trade relations to go sour. In fact, an Act of God (we are talking about the COVID-19 pandemic) had a significant impact on it and contributed to Mexico becoming the US's number one trade partner.
The pandemic disrupted global supply chains, affecting production and shipping processes worldwide. In the case of US-China trade, the disruptions were particularly severe due to strict lockdown measures, factory shutdowns, and logistical challenges in both countries. This led to delays and a reduction in the flow of goods between the US and China.
To add fuel to the fire, the pandemic intensified pre-existing tensions between the US and China, prompting many US companies to reassess their dependence on Chinese manufacturers and seek alternative supply chain strategies to mitigate risks. Many businesses set out to find sourcing and manufacturing locations that could offer long-term stability and reliability.
Growing Nearshoring
Mexico turned out to be the missing piece in this supply chain puzzle and emerged as a prime alternative to China due to its geographical proximity, established trade agreements like the United States-Mexico-Canada Agreement (USMCA), and cheap labor. Thanks to decades of trade agreements and partnerships between both countries, Mexico’s manufacturing capabilities and infrastructure were already well-integrated with the US economy, making it a natural choice for companies looking to nearshore their production.
According to the Baker Institute of Public Policy, by 2027, Mexico’s exports could reach up to $609 billion, an increase from $455 billion in 2022. Additionally, a report by Banorte, a leading Mexican bank and financial service company, projects that between 2024 and 2028, nearshoring could yield “additional profits close to US$168 billion in non-oil exports, which implies an annual average of US$33.6 billion.”
A recent Ministry of Economy report released by the Mexican government states that between January and March 2024, FDI investments amounting to $31 billion were announced, out of which 57% of FDI will be contributed by private sectors based out of the United States. The manufacturing sector seems to be the most sought-after, receiving 54% of the total investment. These spectacular numbers are a testament to the growing nearshoring trend in the US-Mexico borders.
The image depicts logistics real estate, cargo transport, and population distribution across Northern Mexico
Source: Prologis
A significant outcome resulting from nearshoring is the expansion of the 3PL ecosystem in Mexico. According to Statista, the Mexican 3PL market is projected to reach USD 20.89 billion by 2024. This growth is driven by increasing demand for specialized services, particularly in the automotive and electronics sectors, which is fostering innovation and further market expansion.
Similarly, there’s been an increase in warehouse rent and industrial real estate in Mexico since nearshoring caught pace. Greater Mexico City, Tijuana, and Guadalajara recorded the highest annual rent per square meter of industrial real estate among select cities in Mexico in 2024. In the first quarter of 2024, the annual rent for a square meter of industrial space in Monterrey – the largest market in the country – stood at 6.87 U.S. dollars per square meter.
Surprisingly, Mexico and the United States are not the only countries reaping the benefits of nearshoring. China, too, is getting a significant chunk of the pie!
Data source: US Census Bureau and Observation of Economic Complexity
Friends, Foes, and Free Trade
Since the onset of the US-China trade war and the imposition of tariffs on Chinese imports, the number of shipments from Mexico claiming to be de minimis shipments has significantly increased, according to a report published by the Office of Trade. Additionally, a report from Xeneta shows that the number of 20-ft containers shipped from China to Mexico hit 881,000 in the first three quarters of 2023, up from 689,000 in the same period of 2022. These numbers underline the fact that the Chinese importers are circumventing the imposed tariffs using the loopholes in the lesser-known Section 321 to reach American buyers.
Did you know that section 321 imports account for a substantial share of all U.S. e-commerce imports by quantity? In FY 2022, de minimis imports, based on the number of bills of lading, were 83% of total U.S. e-commerce imports – this includes shipments from both Chinese fast fashion sellers like Shein and Temu and US-owned brands.
According to the finding report submitted by the House Select Committee, “Temu and Shein alone are likely responsible for more than 30% of all packages shipped to the United States daily under the de minimis provision and nearly half of all de minimis shipments to the U.S. originate from China.”
Additionally, this loophole in the US has significantly contributed to the earnings of both Shein and Temu. Case in point, Shein has aced the D2C business model, and it eclipsed leading U.S. firms in the category in 2022, with its U.S. revenues growing from under $500 million in 2018 to over a whopping $3 billion in 2022.
In today's unpredictable geopolitical landscape, there are no permanent friends or foes, and international trade dynamics are constantly evolving. A prime example is how China devised newer strategies after the US-China trade war. To circumvent the tariffs and trade barriers imposed by the United States, Chinese companies are increasingly setting up factories in Mexico, christening their products "Made in Mexico." This strategic move allows them to benefit from Mexico's trade agreements with the US, particularly the USMCA, ensuring continued access to the crucial North American market.
However, according to trade experts, Section 321 is likely to undergo some significant changes in the future. The proposed updates may restrict the de minimis exemption for Chinese imports, lower the current $800 duty-free threshold, and require more detailed documentation and inspection at the border. These changes are intended to address misuse of the exemption and promote fair competition
As Mexico and the US embrace this nearshoring wave, both nations stand to reap significant benefits. Streamlined supply chains, innovative industrial growth, and stronger political ties are just the beginning. This dynamic partnership is not only reshaping North American trade but also setting the stage for a more integrated and prosperous future.
Furthermore, this partnership with Mexico is helping the US reduce its dependency on China by diversifying supply chains. As collaboration deepens, the US will implement stricter measures to curb illicit imports and close trade loopholes that China is exploiting, thereby strengthening economic resilience and security.