Will Mexico Shein On?

Mexico has momentum to meet demands from reshoring.

by Ryan Boyle, Senior Economist, Northern Trust

Americans often misunderstand Mexico.  Each spring, we look forward to Mexican-themed gatherings for Cinco de Mayo—never mind that Mexican Independence Day actually falls on September 16.  The menus of some popular Mexican restaurant chains have items not found anywhere south of the border.  And travel to Mexican beach resorts offers wonderful scenery that bears no resemblance to the landscape of most of the nation.

Economically, Mexico does not always command our attention. But that may be changing.  This week, Mexico elected its first female president, Claudia Sheinbaum, who will try to carry on the strong performance engineered by her predecessor, Andrés Manuel López Obrador (AMLO). The results of that effort will have important impacts north of the border and beyond.

For decades, Mexico was beset by high inflation and currency instability.  Its fortunes were yoked to the economic ups and downs of the U.S., with Mexico experiencing more severe swings than those seen in the States.

AMLO had success in changing that pattern.  He agreed to limited concessions to preserve good trade relations with the United States.  The nation's industrial base grew, and in 2023, Mexico overtook China as the U.S.’ largest source of imports. The peso, perennially devalued against the U.S. dollar, showed unusual strength in recent years; the currency was also supported by the Banco de Mexico's hard stance against inflation, which raised rates sooner and more quickly than was seen in advanced economies.

AMLO's agenda came at a cost.  The federal deficit more than doubled during AMLO’s tenure, exceeding one trillion pesos (3.5% of gross domestic product, or GDP). The nation's ratio of national debt to GDP has doubled since 2005.  Unlike the insatiable demand for debt issued by their neighbor to the north, Mexico cannot run such a fiscal imbalance indefinitely.  And reforms left some important gaps: Crime remains significant, with violent crime nationwide on the rise, an impairment to foreign investment and tourism.

Incoming president Sheinbaum will be asked to address a series of other economic issues. State-owned energy producer Pemex has been treated as a cash cow by several past administrations, leaving it as the world’s most heavily-indebted energy firm.  Aside from risk of insolvency, Pemex lacks the capital for exploration and upgrades to cleaner energy production.  Reinvestment in the firm will add to the demands on national coffers.

Mexico has also been burdened by the increased flow of migrants throughout the western hemisphere.  A diminishing share of migrants detained by the U.S. Customs and Border Protection agency are of Mexican origin; most are merely passing through Mexico.  The Mexican government has made only limited reforms to curb this traffic.  Mexico changed policies to reject migrants arriving by air, but overland transit remains heavy.  This will certainly be a point for President Sheinbaum to take up with American leaders

Mexico has also been burdened by the increased flow of migrants throughout the western hemisphere.  A diminishing share of migrants detained by the U.S. Customs and Border Protection agency are of Mexican origin; most are merely passing through Mexico.  The Mexican government has made only limited reforms to curb this traffic.  Mexico changed policies to reject migrants arriving by air, but overland transit remains heavy.  This will certainly be a point for President Sheinbaum to take up with American leaders.

Mexico's greatest opportunity lies in meeting the moment of de-globalization and reshoring.  As U.S. firms reconsider their long-term investments in China, Mexico stands out as a natural destination for manufacturing.  Its location and low-cost labor have given the nation an edge in the production of heavy, difficult-to-ship products like vehicles and plumbing supplies.  Despite the advantages of a free trade agreement, proximity and overlap in time zones, Mexico has struggled to broaden its northbound exports.  Building more productive capacity will require more investment into the nation's infrastructure, especially for roads and energy generation.

Candidate Sheinbaum did not offer a comprehensive plan to support the nation's revenue beyond increasing tax collection and enforcement.  Sufficient funding to reduce the deficit and support growth may require higher taxes.  As election results came in strongly for Sheinbaum’s Morena party, markets reacted negatively.  The fear of greater populist intervention is causing jitters; Sheinbaum’s commitment to keep AMLO’s level-headed finance minister offered some consolation.

Sheinbaum may also raise Mexico’s international profile.  AMLO speaks only Spanish and did not prioritize diplomacy.  Sheinbaum’s fluent English may improve the nation’s global relations and hedge Mexico’s reliance on U.S. trade, which is a growing risk. A potential second Trump term will be concerning for any nation selling to the U.S.; Trump has promised a 10% tariff on all imports.  Even a second Biden term will probably bring a more demanding stance to U.S.-Mexico relations, with greater cooperation required to limit flows of migrants and narcotics.

Both parties are watching Chinese investment into Mexican production as a channel to evade U.S. tariffs.  The U.S. has renewed its protectionist stance to support its automakers’ transition to electric vehicles (EVs).  However, as written, the U.S.-Mexico-Canada (USMCA) free trade agreement has no provisions about the ownership of production, and many other foreign automakers have facilities in the nation.  China is growing its global EV share; Mexico is an established auto producer; both candidates will halt this backdoor to sell into the U.S.

In the long run, Mexico faces challenges far beyond politics. Its climate varies from desert to tropical, and it is poised to become less hospitable in a warming trend. Fresh water is scarce, especially for the nearly 22 million residents of the Mexico City metro area. The agriculture sector will be especially challenged by these climate risks.  Emigration from Mexico fell as the domestic economy offered greater opportunities, but the nation could become a source of climate refugees.

Mexico has enjoyed a prosperous run.  Today, it is well-positioned logistically and geopolitically to make further economic advancements.  Progress will require disciplined budgeting and tactful diplomacy.  If Sheinbaum can achieve this balance, it will be a clear reason for celebration.

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